Paramount Resources Ltd.
Annual Report 2013

Plain-text annual report

Annual Report 2013 1 Financial and Operating Highlights 2 President’s Message 5 2013 Overview Review of Operations 7 Management’s Discussion & Analysis 27 63 Financial Statements IBC Corporate Information ANNUAL MEETING OF SHAREHOLDERS Shareholders are cordially invited to attend the Annual Meeting of Shareholders to be held Thursday May 8, 2014 at 10:30 AM MDT at Centrium Place in the Conference Centre, 332 6th Avenue S.W., Calgary, Alberta. Forward-Looking Statements and Information This document includes forward-looking statements and information that is based on Paramount’s current expectations, estimates, projections and assumptions. Actual results may differ materially from those expressed or implied by the forward-looking statements and information. Readers are referred to the forward-looking statements and other advisories contained at the end of Paramount’s Management’s Discussion and Analysis for the year ended December 31, 2013 contained herein which also includes supplemental advisories related to additional information included in this document. FINANCIAL AND OPERATING HIGHLIGHTS (1)(2) ($ millions, except as noted) Three months ended December 31 2013 2012 % Change Year ended December 31 2013 2012 % Change FINANCIAL Petroleum and natural gas sales Funds flow from operations Per share – diluted ($/share) Net income (loss) Per share – diluted ($/share) Exploration and development expenditures Investments in other entities – market value (3) Total assets Net debt Common shares outstanding (thousands) 57.8 18.3 0.19 0.3 – 175.8 54.6 17.7 0.20 (151.8) (1.69) 166.8 6 3 100 5 OPERATING Sales volumes Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Average realized price Natural gas ($/Mcf) NGLs ($/Bbl) Oil ($/Bbl) Total ($/Boe) RESERVES (4) 102.5 2,668 536 20,290 3.73 74.30 78.92 30.99 104.1 2,110 1,213 20,674 3.45 61.23 79.72 28.70 (2) 26 (56) (2) 8 21 (1) 8 232.5 70.6 0.75 (59.1) (0.63) 624.9 688.5 2,447.8 1,119.2 96,993 106.1 2,498 726 20,914 3.57 74.73 87.47 30.46 197.1 58.1 0.67 (61.9) (0.71) 523.1 704.8 2,037.0 701.4 89,932 98.5 1,873 1,620 19,917 2.72 67.10 83.16 27.04 Natural gas (Bcf) NGLs (MBbl) Light and medium crude oil (MBbl) Total Conventional (MBoe) Oil sands bitumen (MBbl) Total Company (MBoe) Conventional F&D costs excluding facilities & gathering ($/Boe) Conventional reserves replacement NPV10 future net revenue before tax Conventional Total Company Proved December 31 2013 December 31 2012 Proved & Probable December 31 2013 December 31 2012 301.3 36,777 680 87,677 – 87,677 17.79 611% 1,093 1,093 201.9 15,662 1,540 50,857 – 50,857 16.82 336% 456 456 49 135 (56) 72 – 72 6 140 140 450.5 57,844 885 133,813 93,468 227,281 10.87 759% 1,793 2,094 323.7 30,761 2,128 86,842 93,091 179,933 12.18 599% 880 1,259 18 22 5 19 (2) 20 60 8 8 33 (55) 5 31 11 5 13 39 88 (58) 54 – 26 (11) 104 66 (1) Readers are referred to the advisories concerning non-GAAP measures and Oil and Gas Measures and Definitions in the Advisories section of this document. (2) Amounts include the results of discontinued operations. Refer to Paramount’s Management’s Discussion and Analysis for the year ended December 31, 2013. (3) Based on the period-end closing prices of publicly-traded enterprises and the book value of the remaining investments. (4) Working interest reserves before royalty deductions. Net present values were determined using forecast prices and costs and do not represent fair market value. Paramount Resources Ltd. 2013Financial and Operating Highlights 1  PRESIDENT’S MESSAGE I am very pleased to provide the following annual update to the shareholders of Paramount. Significant progress has been made to bring the resources that the Company has captured into production. As I write this message, we are in the final stages of completing the Musreau deep cut gas plant construction project. We have completed several years of property rationalization to narrow our focus onto the assets that we believe will contribute the most to shareholder value creation. Paramount has exited a number of operating areas including North Dakota, Montana, Saskatchewan, Bistcho in northwest Alberta, Cameron Hills in the Northwest Territories, the high water-cut oil properties at Enchant in southern Alberta, the Pembina and Ante Creek areas in central Alberta, and most recently our Chain-Craigmyle area coal-bed methane operations in southern Alberta. During 2013, we allocated over 95% of our exploration and development capital expenditures to the Deep Basin and Montney resources in the Kaybob and Grande Prairie business units, where we believe we can generate the largest returns for our shareholders. Meanwhile, we continue to move forward with our longer-term projects in the Liard Basin and the oilsands opportunities within Cavalier Energy. The oil and gas industry has undergone an immense amount of change as it adjusts to the revolutionary technological advancements in horizontal drilling and multi-stage fraccing. These new drilling and completion technologies have provided for a seemingly unlimited amount of recoverable oil and gas resources. The strategy for much of the industry, including Paramount, has shifted from capturing as much of this resource as possible to capturing the absolute most profitable opportunities available with the understanding that if an opportunity does not compete with the most economic available, it might as well not be owned at all. This is creating a significant shift in individual companies’ portfolios as they exit out of less profitable holdings into the most profitable available; which is the foundation of Paramount’s strategy. The most important thing that a management team in the industry can do today is to allocate its technical staff and capital to the most profitable opportunities, while attempting to realize value from the assets that are less competitive. Paramount has done an excellent job of this, allocating the vast majority of its capital resources primarily to the Deep Basin and Montney assets it has assembled at Musreau, Kakwa, Karr, Gold Creek, Smoky and Resthaven. The Company continues to make great progress on its large-scale projects in the Kaybob core area. The Musreau project is anticipated to commence production in the latter part of the second quarter of this year. Paramount has over 66 gross wells behind pipe, the majority of which are completed and tied-in, with first month productive capacity of over 300 MMcf/d gross (230 MMcf/d net) plus additional natural gas liquids. These wells will come on-stream when the Company’s new facilities commence production. At the same time, Paramount’s production mix will evolve from 85 percent gas and only 15 percent liquids to about 55 percent gas and 45 percent liquids. Combined with significant decreases in our per unit cost structure, this product mix transformation will result in an expansion of our netback per Boe by over two times. The increases in production, combined with higher netbacks, are expected to result in cash flow levels that are approximately 10 times the prior amounts. Paramount expects to be able to replicate its Musreau gas plant construction project many times over with the resources it has already captured and controls. Paramount Resources Ltd. 2013President's Message2 During 2013, Paramount achieved further operational and financial performance improvements. Production increased 5 percent to 20,914 Boe/d in 2013, up from 19,917 Boe/d in 2012, despite divestitures and various significant third party downstream capacity restrictions throughout the year. Operating costs per Boe continue to decrease as we bring on incremental low cost production and, at the same time, benefit from the results of our divestitures of higher cost production in the last several years. Per unit netbacks increased to $16.54 per Boe in 2013 from $12.21 per Boe in 2012. Cash netbacks increased to $126.2 million in 2013 from $88.9 million in 2012 as a result of higher production levels and higher netbacks. The Company’s total capital spending, excluding land acquisitions and capitalized interest, totaled $704.1 million in 2013, funded mainly through a combination of equity, debt and asset sales. Paramount was very successful in 2013 adding reserves at a low cost. Proved reserves increased by 72 percent from 50.9 MMBoe at the end of 2012 to 87.7 MMBoe at year-end 2013. Conventional proved plus probable reserves increased from 86.8 MMBoe at year-end 2012 to 133.8 MMBoe at year-end 2013, an increase of 54 percent. The Company achieved conventional reserves replacement ratios of over 600 percent for proved reserves and over 750 percent for proved plus probable reserves. Excluding capital spending on facilities, which are expected to provide processing capability for several decades, these reserves were added at a very efficient $17.79/Boe for proved reserves and $10.87/Boe for proved plus probable reserves. Paramount’s wholly-owned oilsands subsidiary, Cavalier Energy, had a successful year of operations. The year was spent working through the regulatory process for the initial 10,000 Bbl/d phase at its Hoole project, with this approval now expected mid-year 2014. Cavalier updated its independent engineering evaluation of the Hoole project resulting in an additional 27 million barrels of recoverable resource, which now totals 840 million barrels, although the value of this project slipped slightly to an NPV of $1.8 billion, discounted at 10% before tax. Cavalier continues to evaluate the funding alternatives for the initial phase of construction, although this has proven difficult in the current economic environment. Fox Drilling brought into service two new, state-of-the-art, triple sized walking drilling rigs. This brings the total rigs owned and operated by Fox to five. Paramount has been the exclusive user of these Fox rigs throughout 2013, as these rigs are perfectly suited to our operations in the Kaybob area. The familiarity with Paramount’s operations has allowed the Fox Drilling team to achieve significant reductions in time and costs to drill wells in the area, adding to the positive economics in the Kaybob area plays. The Company moved forward with its initial Besa River shale gas exploration activities in the Liard Basin in 2012. Drilling and completion operations were finished on the Patry b-40-I well, with production commencing in late-2013. Drilling of the Dunedin d-57-D vertical well was completed and the Company made the decision to pursue drilling and completing a horizontal leg. Paramount encountered some setbacks running the production casing in the hole and anticipates finishing drilling operations in the near future, with the completion of the well to follow later in the year. Paramount has also spudded an additional well at d-71-G, which has been suspended at the intermediate casing point due to spring break-up conditions. Paramount Resources Ltd. 2013President's Message3 North American gas markets finally received some positive momentum as the continent has been under the influence of a Polar Vortex for most of this winter. With only modest increases in North American gas supply, incremental heating demand across the continent has resulted in unprecedented storage withdrawals of nearly three Tcf, with prices spiking materially at times during periods of extreme cold throughout the winter. Natural gas inventories in North America have dropped below one Tcf as storage caverns have been depleted by the significant withdrawals. It is expected that prices will remain strong as storage operators attempt to restore inventory levels in time for the next winter heating season. The same price impact has been seen in natural gas liquids markets, as propane prices in particular have spiked to all time record highs due to these significant heating demands. Crude oil prices have been fairly stable year-over-year at or just below the $100 per barrel range and condensate continues to trade in Alberta at a premium to crude oil prices as demand from oilsands operations continues to materially outpace production in Alberta. The Company is fortunate to have captured and control some of the best and most economic oil and natural gas prospects available in North America. Paramount continues to maintain capital discipline, directing investments towards the plays that exceed our economic hurdles at current commodity prices, while balancing risks. Approximately 90% of the Company’s 2014 conventional capital expenditure budget will be allocated to the Kaybob and Grande Prairie plays, which provide compelling returns in the current commodity price environment. Paramount has provided 2014 capital spending guidance of $650 million on exploration and development activities including $50 million on its Strategic Investments, mainly on shale gas exploration activities in the Liard Basin. Production is anticipated to remain at current levels until our new Musreau deep cut plant comes into service. Corporate production is expected to ramp up to levels that will exceed 50,000 Boe/d at some point in 2014, with the timing dependent on the completion of expansions to downstream de-ethanization facilities in which Paramount has secured long-term firm service capacity. Paramount expects production to exceed 70,000 Boe/d as we move into 2015 with the achievement of full extraction capability from the new facilities. By 2015, after these major projects are on production, Paramount’s cash flow from operations will begin to exceed our capital spending. Paramount’s management team is extremely excited to see the results of the many years of hard work on these projects, and looks forward to delivering continued growth from these projects and our resources in the future. J.H.T. Riddell President and Chief Operating Officer March 2014 Paramount Resources Ltd. 2013President's Message4  2013 OVERVIEW Oil and Gas Operations  Proved reserves increased 72 percent year-over-year to 87.7 MMBoe, after production of 7.6 MMBoe and dispositions of 2.2 MMBoe (replacement ratio of 6.1 times).  Total proved and probable ("P+P") reserves increased 47.3 MMBoe to 227.3 MMBoe, with conventional P+P reserves increasing 54 percent to 133.8 MMBoe (replacement ratio of 7.6 times) and probable oil sands bitumen reserves increasing to 93.5 MMBoe.  Year-end 2013 P+P reserves included 57.8 MMBbl of NGLs (43 percent of conventional P+P reserves), representing an 88 percent increase in NGLs reserves over 2012.  The value of year-end 2013 conventional P+P reserves (10% discount, before tax) more than doubled to $1.8 billion.  Kaybob COU P+P finding and development costs, excluding major facilities and gathering system project construction costs, were $10.21 per Boe compared to $10.31 per Boe in 2012.  Sales volumes will begin to ramp-up as the Musreau Deep Cut Facility starts up in the second quarter of 2014. Paramount’s sales volumes are expected to reach approximately 50,000 Boe/d in 2014 and increase to approximately 70,000 Boe/d in 2015.  Paramount’s behind pipe well inventory in the Kaybob Deep Basin has increased to 66 (47.9 net) wells with estimated first month deliverability of approximately 300 MMcf/d (230 MMcf/d net).  Kaybob COU sales volumes increased 23 percent to 13,402 Boe/d in 2013 compared to 10,910 Boe/d in 2012. Total Company sales volumes increased 5 percent in 2013 to average 20,914 Boe/d, despite third-party downstream disruptions that curtailed production by approximately 3,500 Boe/d and the sale of 1,500 Boe/d of production.  NGLs volumes are projected to increase from 12 percent of total sales volumes in 2013 to approximately 40 percent by the end of 2014.  Netbacks increased by 42 percent to $126.2 million in 2013 from $88.9 million in 2012.   In 2013, the Company sold non-core properties in Alberta, the Northwest Territories and the United States, realizing proceeds of approximately $70 million in cash and publicly trading securities. In February 2014, Paramount entered into an agreement to sell coal bed methane properties producing approximately 6 MMcf/d in the Chain-Delia area of Alberta for approximately $12 million in common shares of a TSX-Venture listed Company. Corporate  The Company raised a total of approximately $360 million in 2013 through equity offerings and the $150 million re-opening of its 7⅝ percent senior notes due 2019.  In November 2013, Paramount’s bank credit facility was increased from $450 million to $600 million based on progress made in the Kaybob Deep Basin development and increases in reserves to the end of September 2013.  Total 2013 capital spending was approximately $100 million lower than Paramount’s $800 million capital guidance because of severe weather conditions in late-2013 and other factors which deferred spending into 2014. Paramount Resources Ltd. 20132013 Overview5  Strategic Investments  The market value of Paramount’s investments in publicly-traded and private corporations was approximately $690 million ($7.10 per Paramount share) as of December 31, 2013.  In the Liard Basin, the Company’s first horizontal shale gas exploration well at Patry was brought-on production in late-December. At Dunedin, the Company plans to complete its d-57-D shale gas exploration well and drill an additional shale gas exploration well in 2014 to preserve lands.  Cavalier Energy anticipates regulatory approvals for the initial 10,000 Bbl/d phase of its Hoole project will be received by mid-2014. Front-end engineering and design work was completed in 2013.  Fox Drilling’s two new walking rigs are both currently drilling separate 10-well pads in the Kaybob COU. Paramount Resources Ltd. 20132013 Overview6  REVIEW OF OPERATIONS (1) Year ended December 31 Sales Volumes Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Netback ($ millions) (2) Natural gas revenue NGLs revenue Oil revenue Royalty and sulphur revenue Petroleum and natural gas sales Royalties Operating expense and production tax Transportation 2013 106.1 2,498 726 20,914 2012 % Change 98.5 1,873 1,620 19,917 8 33 (55) 5 ($/Boe)(3) 3.57 74.73 87.47 – 30.46 (1.42) (9.52) (2.98) 16.54 138.3 68.1 23.2 2.9 232.5 (10.8) (72.7) (22.8) 126.2 ($/Boe)(3) 2.72 67.10 83.16 – 27.04 (2.27) (9.58) (2.98) 12.21 98.2 46.0 49.3 3.6 197.1 (16.5) (69.9) (21.8) 88.9 % Change in $mm 41 48 (53) (19) 18 (35) 4 5 42 Netback (1) Amounts include the results of discontinued operations. Refer to Paramount’s Management’s Discussion and Analysis for the year ended December 31, 2013 for further details. (2) Readers are referred to the advisories concerning non-GAAP measures and oil and gas measures and definitions in the Advisories section of this document. (3) Natural gas revenue shown per Mcf. Paramount’s operations continue to focus along the Deep Basin trend in west central Alberta, where the Company holds extensive multi-zone mineral rights to 1,220 (774 net) sections of land, including 394 (326 net) sections of Montney rights. Over the past few years, the Company has been constructing natural gas processing facilities and securing long-term NGLs transportation and processing capacity to provide the necessary infrastructure to maximize the value of Paramount’s liquids-rich Deep Basin resources. The Company’s first major natural gas processing facility in the Deep Basin, a 45 MMcf/d refrigeration facility (the "Musreau Refrig Facility") was commissioned in the first quarter of 2012 and a second major facility, the 200 MMcf/d Musreau Deep Cut Facility, is scheduled to start up in the second quarter of 2014. This processing capacity, in conjunction with the expected alleviation of third-party downstream NGLs bottlenecks, will enable the Company to more than double current production to reach approximately 50,000 Boe/d in 2014 and more than triple production to approximately 70,000 Boe/d in 2015. NGLs volumes are projected to increase from 12 percent of total production in 2013 to approximately 40 percent by the end of 2014, which will significantly increase per unit netbacks. In Kaybob, mechanical construction of the Musreau Deep Cut Facility is substantially complete and advance drilling continues to increase the volumes of behind pipe production that will feed the Musreau Deep Cut Facility and the deep cut expansion at Smoky. In Grande Prairie, the Company is advancing the exploration and delineation of its Montney lands northwest of Musreau at Karr-Gold Creek. Expansions to third-party pipeline systems and NGLs processing facilities downstream of Paramount’s properties are being completed, which will provide Paramount with the required transportation and NGLs processing capacity to achieve planned production increases. As the Company continues to focus on its low-cost, liquids-rich properties, further divestitures of non-core properties were completed in 2013 in Alberta, the Northwest Territories and the United States. Paramount Resources Ltd. 2013Review of Operations7  Sales volumes increased five percent in 2013, despite third-party disruptions which curtailed production by approximately 3,500 Boe/d and the sale of approximately 1,500 Boe/d of production. The Company’s netback increased 42 percent in 2013, primarily as a result of higher revenue due to increased prices and higher natural gas and NGLs volumes. Royalties decreased because of a greater proportion of production qualifying for Alberta new well royalty incentive programs and the impact of annual gas cost allowance adjustments. Paramount Resources Ltd. 2013Review of Operations8  Kaybob Year ended December 31 Sales Volumes Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Exploration and Development Expenditures ($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering 2013 72.1 1,365 29 13,402 347 150 497 2012 % Change 59.5 924 62 10,910 201 162 363 21 48 (53) 23 73 (7) 37 Total Land Holdings (sections) Wells Drilled Gross 682 31 Net 428 26 Gross 788 27 Net 446 21 The Kaybob corporate operating unit ("COU") operates in west central Alberta, where its core properties are in the Deep Basin at Musreau, Smoky and Resthaven. Paramount has assembled 682 (428 net) sections of extensive multi-zone mineral rights within the Kaybob COU. The Company’s drilling activities are focused on the Montney, Falher and Dunvegan formations, which are high pressure, liquids rich, tight gas formations with large reserves potential. Paramount has approximately 235 (200 net) sections of Montney rights in the Kaybob COU. In 2013, the Company received regulatory approval to increase well densities on a portion of its Montney lands at Musreau and now has a contiguous block of 36 sections approved for up to five wells per section. Densities of ten or more wells per section per formation are anticipated to be required to produce the recoverable resources in place, representing a multi-decade inventory of drilling locations. In 2013, Paramount continued to execute the large-scale development of its Deep Basin lands, advancing construction of the Musreau Deep Cut Facility, participating in the deep cut expansion of the non- operated Smoky facility and drilling and completing wells to increase production deliverability in advance of the start-up of these new facilities. The Company continued to achieve significant reserves growth in 2013 as a result of its development activities in the Kaybob Deep Basin. Further increases in reserves volumes are expected as development drilling continues in 2014. With the first full year of operations of the Musreau Refrig Facility, Kaybob COU sales volumes increased 23 percent in 2013 to 13,402 Boe/d, despite continued capacity constraints and third-party disruptions. Operating expenses, net of processing income, averaged $4.34 per Boe for the Kaybob COU in 2013 and less than $4.00 per Boe within the Musreau area. The Musreau Refrig Facility provides significant savings to the Company through the elimination of third-party processing fees. Following start-up of the Musreau Deep Cut Facility, per unit operating costs are expected to decrease as fixed costs will be applied over significantly higher production volumes. The downstream NGLs bottlenecks that constrained Paramount’s production in 2013 are expected to alleviate in 2014 with the commencement of long-term firm service contracts to transport and process NGLs volumes extracted from Company’s natural gas production. These contracts, together with the Paramount Resources Ltd. 2013Review of Operations9  completion of the deep cut facilities expansions will allow the Company to produce from its behind-pipe inventory of 66 (47.9 net) wells, increasing production, netbacks and cash flow. Kaybob Wells Paramount completed the drilling of 31 (26.2 net) wells in the Kaybob COU in 2013, including 13 (12.3 net) Montney wells and 16 (11.9 net) Falher wells. The majority of these new wells have been completed and tied-in and will be brought-on production when the Musreau Deep Cut Facility commences operation. The 2013 drilling program included six pad sites that accounted for 19 of the 31 wells drilled. In addition, Paramount’s two walking drilling rigs are each drilling 10-well Montney pads, which are expected to be finished drilling in the second quarter of 2014. Currently, Kaybob area production volumes are mainly from leaner Cretaceous wells in which Paramount’s working interest generally ranges from 50 to 100 percent. These wells, primarily producing from the Falher formation, have on average performed in accordance with anticipated type curves and expected liquids yields. NGLs transportation and fractionation capacity constraints have continued to limit Paramount’s ability to bring Montney formation wells on production due to their high liquids content. Where NGLs capacity is available, the Company is producing selected Montney wells at restricted flow rates, to recover load oil, cleanup wellbores and obtain production data before being shut-in to await the start-up of the Musreau Deep Cut Facility. Paramount has transitioned from drilling single delineation wells to commercial resource development where multiple wells are drilled on pad sites. The use of multi-well pad sites provides capital efficiencies by minimizing mobilization and de-mobilization costs, as well as reducing equipping and tie-in costs through the use of common facilities. Paramount’s walking rigs can move between wells and resume drilling operations within two hours, with the drill pipe standing in the derrick. Drilling techniques continue to be refined, including bit selection and drilling fluids, allowing wells to be drilled in shorter time periods. The Company has also reduced completion costs by improving pumping techniques, modifying frac sizing and spacing, recycling the frac oil, and securing lower costs for services, equipment and completion fluids. Each well on the 10-well pads is expected to be drilled in about 30 days, compared to an average of 41 days for Montney wells drilled in 2013, and cost approximately $10 million to drill, complete and tie- in. In 2014, the Kaybob COU’s drilling program will primarily focus on drilling Montney wells from pad sites located in the northern portion of the Company’s Kaybob area lands, where liquids yields are expected to be the highest. As of February 28, 2014, the Company’s behind pipe well inventory in the Kaybob Deep Basin was 66 (47.9 net) wells, including wells previously produced that have been temporarily shut-in due to capacity constraints, with estimated first month deliverability of approximately 300 MMcf/d (230 MMcf/d net) of raw gas. Production from these wells will be processed through the Musreau and Smoky deep cut facilities and Paramount’s other Kaybob area capacity. Kaybob NGLs Extraction Process Paramount’s production will ramp-up as the Musreau Deep Cut Facility starts up in the second quarter, with NGLs being extracted and delivered downstream for sale or to third-party facilities for further processing. Following the completion of expansions to Company-owned natural gas processing and downstream third-party NGLs processing facilities, the Kaybob NGLs extraction process ("C2+ Recovery Mode") will be as follows:  Production volumes will be transported from wellsites via a Company-owned gathering system to the Musreau Deep Cut Facility. Paramount Resources Ltd. 2013Review of Operations10   Condensate will be separated from the liquids-rich gas stream at the plant inlet and treated through the condensate stabilizer system to remove lighter hydrocarbons, creating a higher value stabilized pentanes-plus product ("C5+") that will be shipped through a third-party liquids pipeline system for sale. Lighter hydrocarbons removed from the C5+ through the stabilization process will be returned to the gas stream.  Following separation of the C5+, the liquids-rich natural gas stream will pass through the amine processing train to sweeten the gas, and then will be cooled to approximately minus 100 degrees Celsius to extract substantially all remaining NGLs from the gas stream. When operating in full ethane recovery mode, the Musreau Deep Cut Facility is designed to extract approximately 90 percent of the ethane and virtually all propane, butane and heavier hydrocarbons in the gas stream to create an "ethane plus" NGLs product ("C2+"). The C2+ stream will be shipped through a third- party liquids pipeline system to Fort Saskatchewan for further processing at third-party NGLs processing facilities.  At Fort Saskatchewan, the C2+ volumes will first be processed through a third-party de-ethanization facility, where ethane will be extracted and then sold to a third party under a long-term ethane sales agreement, and the remaining stream of propane, butane and heavier hydrocarbons ("C3+") will be fractionated and sold.  Following the extraction of NGLs, dry natural gas, with a heat content of approximately 1,010 btu per standard cubic foot, will be delivered from the Musreau Deep Cut Facility to a third-party natural gas pipeline system for sale. Until third party de-ethanization capacity is available, the Musreau Deep Cut Facility will be operated at warmer temperatures, resulting in most of the ethane remaining in the gas stream ("C3+ Recovery Mode") and the deep cut plant creating a "propane plus" product comprised primarily of propane, butane and heavier hydrocarbons. Paramount’s NGLs sales volumes and revenue will be lower during C3+ Recovery Mode compared to C2+ Recovery Mode, but these impacts will be mostly offset by higher natural gas sales with the ethane remaining in the gas stream, which will increase both the sales value and sales volume of natural gas. Kaybob Natural Gas and Condensate Processing Capacity At the end of 2013, Paramount had 79 MMcf/d of net owned and firm service natural gas processing capacity in the Kaybob COU, which equates to approximately 15,500 Boe/d of potential sales volumes. Upon completion of the Musreau Deep Cut Facility, the condensate stabilizer expansion and the non- operated Smoky Deep Cut Facility in 2014, the Company’s net owned and firm service contracted natural gas and NGLs processing capacities will increase to over 300 MMcf/d in the Kaybob COU that will provide over 85,000 Boe/d of gross sales volume capacity. This capacity will be used to process Paramount’s production as well as unavoidably commingled third-party volumes for a fee. Kaybob COU sales volumes will ramp up over the first few months following startup of the Musreau Deep Cut Facility, as the operations team optimizes the facility’s equipment and processes. Initial volumes processed through the new facility will be primarily from leaner Cretaceous wells in which Paramount’s working interest generally ranges from 50 percent to 100 percent. As these initial production volumes decline, new 100 percent working interest Montney wells will be brought on production, which will increase liquids production and Paramount’s working interest share of sales volumes. The commissioning of the amine processing train ("Amine Train") and condensate stabilizer expansion will increase the Company’s flexibility for processing sour gas production and for stabilizing incremental liquids volumes. Paramount’s midstream agreements commencing in the second quarter of 2014 provide long-term firm service transportation and processing capacity for NGLs volumes extracted from the Company’s Kaybob Paramount Resources Ltd. 2013Review of Operations11  area natural gas production. The NGLs processing agreements initially provide for the fractionation of C3+ streams, with C2+ Recovery Mode to commence upon completion of third-party de-ethanization facility expansions. The first phase of these expansions, previously scheduled for completion in the third quarter of 2014, is now expected to be complete in late-2014. Third-party de-ethanization capacity is expected to increase further with the completion of a second expansion phase in 2015. The Company is in discussions with midstream companies to secure short-term access to de-ethanization capacity in advance of the completion of these third-party expansions. The Company already has in place a long- term agreement for the sale of ethane. The elements and estimated timing of additional Kaybob area processing capacity are shown below and are based on the expectation that planned third-party downstream de-ethanization capacity becomes available in late-2014: Kaybob Processing Capacity (1)(2) Boe/d 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 Condensate Stabilizer Expansion Smoky Deep Cut Expansion (Non-op) Musreau Deep Cut C3+ Recovery Mode Musreau Deep Cut Partial C2+ Recovery Mode Musreau Deep Cut Full C2+ Recovery Mode Current Capacity - 31-Mar-14 30-Jun-14 30-Sep-14 31-Dec-14 31-Mar-15 30-Jun-15 30-Sep-15 31-Dec-15 (1) Aggregate processing capacity of the Kaybob COU's owned and firm service natural gas and condensate processing facilities. These processing capacity estimates are subject to a number of assumptions and risks and should not be construed as projections of Paramount's Kaybob area production volumes at or by any particular date or dates. The Company's net sales volumes in the Kaybob COU will be lower than the capacity shown because of a number of factors including, but not limited to: a) some unavoidably commingled third-party volumes will be processed using Paramount capacity; b) the liquids content of wells will vary; c) production volumes sufficient to fill capacity will not be available in all periods and under certain conditions; and d) during maintenance periods and at other times, the facilities will not operate at design capacity. (2) Increases in Kaybob processing capacity in the chart above are shown at the mid-point of the quarter in which new facilities and facilities expansions are scheduled to be completed. However, the completion of such facilities may occur at any point during such period or may occur in a different period and the actual ramp-up will be different than depicted. See the Advisories section of this document. Paramount Resources Ltd. 2013Review of Operations12  Paramount Infrastructure Projects The Musreau Deep Cut Facility is scheduled to startup in the second quarter of 2014. Mechanical construction is substantially complete and activities at the site are focused on completing the final stages of the electrical and instrumentation work. Commissioning of individual components of the facility commenced in December 2013. Activities at the site were impacted by third-party labour shortages and severe weather conditions in late-January and February 2014 which have prolonged the remaining work and the commissioning process. As a result of these changes, the Company is accelerating work originally planned for later in the year to integrate the Amine Train and the condensate stabilizer expansion to minimize downtime later in 2014 when these additional components are started-up. The expected total cost of the facility remains at approximately $190 million, in-line with the original budget. The Company continues to advance the construction of the Amine Train at the Musreau Deep Cut Facility site, which will provide the capability to treat sour gas production at the facility instead of at well sites. This project is expected to cost approximately $45 million and will reduce equipping costs per well by over $1 million and result in lower ongoing well operating costs. Major components for the Amine Train are being delivered to the plant site, with construction and installation activities scheduled to be completed in the fourth quarter of 2014. Condensate yields from Paramount’s new Montney wells at Musreau exceeded expectations in 2012. As a result, the Company initiated a project to expand the condensate stabilizer system servicing the Musreau Deep Cut Facility and the Musreau Refrig Facility by 15,000 Bbl/d (the "Stabilizer Expansion") to process the anticipated incremental liquids volumes. Long-lead time components have been ordered and the project is expected to be completed in the fourth quarter of 2014 at a cost of approximately $45 million. Upon start-up of the Musreau Deep Cut Facility, the Kaybob COU will have condensate stabilization capacity of approximately 8,500 Bbl/d, which will increase to approximately 23,500 Bbl/d when the Stabilizer Expansion becomes operational. Until the Stabilizer Expansion is completed, Kaybob field condensate production in excess of capacity will be trucked to other Paramount and third-party facilities for processing. Paramount is continuing the preliminary planning for construction of additional natural gas processing facilities in the Deep Basin. The Company currently anticipates that a refrigeration process will be used to extract C3+ NGLs as opposed to a deep cut recovery process because the availability of long-term sales contracts for incremental ethane volumes is believed to be limited. The specific location, capacity and construction timeline of proposed new facilities are currently under review. A decision to proceed is anticipated later in 2014 following the ramp-up of the Musreau Deep Cut Facility and obtaining additional well performance data, including NGLs yields. To ensure access to downstream NGLs transportation and fractionation for future natural gas processing facilities, Paramount has secured capacity in further expansions to third-party NGLs transportation and fractionation systems servicing the Deep Basin that are expected to come on-stream beginning in mid- 2016. The deep cut expansion of the non-operated processing facility at Smoky (the "Smoky Deep Cut Facility") continues to progress. The Company will have a 20 percent interest in the expanded facility, an increase from its current 10 percent interest in the existing 100 MMcf/d dew point facility. The Smoky Deep Cut Facility will initially have a working capacity of 200 MMcf/d (40 MMcf/d net) upon start-up, increasing to 300 MMcf/d (60 MMcf/d net) through the later installation of an incremental 100 MMcf/d of compression. As a plant owner, Paramount has the option at any time to request installation of this additional compression. Paramount Resources Ltd. 2013Review of Operations13  Site work on the Smoky Deep Cut Facility continues, with process equipment delivered and mechanical work underway. The expansion is scheduled to be commissioned in the third quarter of 2014. Paramount was advised by the third-party operator that it expects the existing Smoky 100 MMcf/d dew-point facility will be shut-down for approximately two months commencing in the second quarter of 2014 to complete its integration with the expansion. Paramount’s share of the Smoky Deep Cut Facility expansion costs is expected to total $75 million, of which approximately $50 million has been incurred to December 31, 2013. Upon completion of the Company’s new facilities, Paramount’s net owned and firm service processing capacity will increase to over 300 MMcf/d in the Kaybob COU, providing over 85,000 Boe/d of gross sales volume capacity. The Kaybob COU plans to begin ramping up production in the second quarter of 2014 and production levels are expected to continue to increase throughout 2014 and 2015. The increases in production together with a higher proportion of NGLs, will generate significantly higher cashflows for Paramount. Grande Prairie Year ended December 31 Sales Volumes Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Exploration and Development Expenditures ($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering 2013 20.0 809 322 4,459 112 16 128 2012 % Change 20.9 749 307 4,536 70 33 103 (4) 8 5 (2) 60 (52) 24 Total Land Holdings (sections) Wells Drilled Gross 538 14 Net 346 9 Gross 577 10 Net 379 7 The Grande Prairie COU operates in the Peace River Arch area of Alberta, where its principal properties include Karr-Gold Creek, Valhalla and Mirage. Activities in the Grande Prairie COU are currently focused at Karr-Gold Creek, where the Company has approximately 159 (126 net) sections of Montney rights that have exhibited similar reservoir and fluid characteristics to competitors’ offsetting lands and the Company’s Montney lands at Musreau, approximately six miles to the south. As of December 31, 2013, Paramount has drilled a total of six (6.0 net) horizontal middle-Montney wells at Karr-Gold Creek. All six wells have been completed and brought-on production at restricted rates because of constraints in downstream natural gas and NGLs processing capacity. The drilling of three additional middle-Montney re-entry wells planned for the fourth quarter of 2013 was delayed to the first quarter of 2014 due to site access restrictions caused by heavy snowfall. In 2013, the Company also participated in seven (2.1 net) non-operated wells in the Karr-Gold Creek area. Positive results from the Company’s middle-Montney wells and offsetting industry wells confirm that the Montney trend extends from Kaybob northwest onto the Company’s lands at Karr-Gold Creek. To further the exploitation of this resource, the Company has secured long-term firm service natural gas processing Paramount Resources Ltd. 2013Review of Operations14  and liquids transportation capacity for its Karr-Gold Creek production beginning in the second quarter of 2014. This will provide long-term capacity that will allow the Grande Prairie COU to continuously produce its wells and is expected to lower per-unit operating costs. In 2014, the Company plans to drill up to 7 wells to continue the delineation of its middle and upper Montney lands at Karr-Gold Creek. At Valhalla, Paramount is continuing to optimize its production through available third-party capacity and plans to drill up to three wells to manage expiries. Sales volumes in the Grande Prairie COU averaged 4,459 Boe/d in 2013, a decrease of two percent compared to 2012. Third-Party Disruptions continued to impact operations during 2013, reducing sales volumes by approximately 1,500 Boe/d, primarily at Valhalla. In the second quarter of 2013, Paramount completed the sale of the majority of its holdings in the Ante Creek area of Alberta in exchange for $13.5 million in common shares of RMP Energy Inc. Southern (1) Year ended December 31 Sales Volumes Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Exploration and Development Expenditures ($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering 2013 9.5 255 342 2,179 7 – 7 2012 % Change 9.8 171 1,016 2,814 23 3 26 (3) 49 (66) (23) (70) (100) (73) Total Land Holdings (sections) Wells Drilled (1) Amounts include the results of discontinued operations. Refer to Paramount’s Management’s Discussion and Analysis for the year ended December 31, Gross 719 1 Net 356 1 Gross 627 4 Net 432 2 2013 for further details. In the first quarter of 2013, the Company sold its non-operated joint venture operations and lands in North Dakota for gross proceeds of approximately US$22 million. Combined with the 2011 sale of undeveloped land in North Dakota for US$40 million and the 2012 sale of operated properties in North Dakota and Montana for US$70 million, approximately US$132 million in cash proceeds were realized from the sale of these high royalty, high operating cost United States properties. Total sales proceeds significantly exceeded the carrying value of these assets. In February 2014, Paramount entered into an agreement to sell its properties in the Chain-Delia area of Alberta for approximately $12 million in common shares of Marquee Energy Ltd., a TSX Venture Exchange listed company. These properties had average 2013 production of approximately 6 MMcf/d of natural gas, and include approximately 160 (120 net) sections of land. This transaction is scheduled to close in the first quarter of 2014. Paramount Resources Ltd. 2013Review of Operations15  Following these dispositions, the Southern COU’s main producing property will be at Harmattan, which produced approximately 600 Boe/d in the fourth quarter of 2013. The Company plans to drill up to four exploratory wells on its Southern properties in 2014. Northern (1) Year ended December 31 Sales Volumes Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Exploration and Development Expenditures ($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering 2013 2012 % Change 4.5 69 33 874 – 1 1 8.3 29 235 1,657 21 7 28 (46) 138 (86) (47) (100) (86) (96) Total Land Holdings (sections) (1) Amounts include the results of discontinued operations. Refer to Paramount’s Management’s Discussion and Analysis for the year ended December 31, Gross 334 Net 220 Gross 627 Net 432 2013 for further details. Paramount owns approximately 65 (65 net) sections of land in the Birch-Umbach area of Northeast British Columbia that are prospective for liquids-rich natural gas production from the Montney formation. The Company’s activities at Birch have been directed towards drilling and producing new wells in order to evaluate well performance, including flow rates and liquids ratios. Three horizontal Montney wells completed to date are being produced through a 3 MMcf/d pilot facility, with NGLs yields averaging approximately 60 Bbl/MMcf of raw gas. Paramount plans to drill an additional four horizontal Montney wells at Birch in the second half of 2014, two of which are expected to be completed and tied-in by the end of the year. BIRCH - UMBACH In March 2013, Paramount sold its properties in the Bistcho area of Alberta and the the Cameron Hills area of Northwest Territories for net proceeds of $9.1 million. Average 2012 sales volumes for these properties were approximately 1,000 Boe/d. Paramount Resources Ltd. 2013Review of Operations16  Reserves Conventional Paramount continued to achieve strong year-over-year reserves growth in 2013, driven by the Company’s Deep Basin development program. Proved reserves additions in 2013 totaled 46.7 MMBoe, resulting in an increase of 72 percent over 2012 proved reserves, after 2013 production of 7.6 MMBoe and dispositions of 2.2 MMBoe. Proved & probable ("P+P") reserves additions in 2013 totaled 58.0 MMBoe, resulting in a 54 percent increase over 2012 P+P reserves, after 2013 production of 7.6 MMBoe and dispositions of 3.4 MMBoe. Year-over-year, proved reserves per share increased 60 percent and conventional P+P reserves per share increased 43 percent. NGLs reserves increased significantly in 2013, both on a volume basis and as a percentage of total reserves, as the Company’s drilling program continues to focus on the liquids-rich Montney formation. Proved NGLs reserves totaled 36.8 MMBbl as of December 31, 2013, representing 42 percent of total proved reserves, compared to 15.7 MMBbl and 31 percent of total proved reserves in 2012. P+P NGLs reserves totaled 57.8 MMBbl as of December 31, 2013, representing 43 percent of conventional P+P reserves, compared to 30.8 MMBbl and 35 percent of conventional P+P reserves in 2012. As of December 31, 2013, the value of proved reserves (discounted at 10 percent, before tax) increased 140 percent to $1.1 billion and the value of conventional P+P reserves (discounted at 10 percent, before tax) increased 104 percent to $1.8 billion. Hoole Oil Sands Bitumen In addition to its conventional reserves, the Company’s wholly-owned subsidiary, Cavalier Energy Inc. ("Cavalier Energy"), has 93.5 MMBbl of probable bitumen reserves attributed to its proposed 10,000 barrel per day Grand Rapids formation oil sands development planned at Hoole, Alberta. Bitumen reserves volumes for the Hoole Grand Rapids were recognized in 2012 following the filing of regulatory applications for project approval. MBoe 100,000 80,000 60,000 40,000 20,000 0 Proved Reserves 2009 2010 2011 2012 2013 Conventional Reserves MBoe 250,000 200,000 150,000 100,000 50,000 0 Proved & Probable Reserves 2009 2010 2011 2012 2013 Conventional Reserves Bitumen Paramount Resources Ltd. 2013Review of Operations17  The Company’s working interest reserves and before tax net present value of future net revenues as of December 31, 2013 using forecast prices and costs are as follows: Reserves Summary (1) Gross Reserves Before Tax Net Present Value (3) ($ millions) Light & Medium Crude Oil (MBbl) Natural Gas (Bcf) 183.6 7.4 110.4 301.3 149.2 450.5 – – – 680 – – 680 206 885 – – – Conventional Proved Developed Producing Developed Non-producing Undeveloped Total Proved Total Probable Total Proved & Probable Conventional Non-Conventional - Oil Sands Bitumen Total Proved Total Probable Total Proved & Probable Non-Conventional Natural Gas Liquids Bitumen (MBbl) (MBbl) Total (MBoe) (2) Discount Rate 0% 10% 6,759 10,708 19,310 36,777 21,067 57,844 38,034 – 11,940 – 37,703 – 87,677 – – 46,136 – 133,813 – – – – 93,468 93,468 – 93,468 93,468 841 232 692 1,765 1,251 3,016 – 1,902 1,902 591 208 294 1,093 700 1,793 – 301 301 Total Company Total Proved Total Probable Total Proved & Probable (1) Columns may not add due to rounding. (2) Refer to the Oil and Gas Measures and Definitions and other advisories in the Advisories section of this document. (3) The estimated net present values disclosed in this document do not represent fair market value. Revenues and expenditures were calculated based on 87,677 93,468 139,604 93,468 227,281 36,777 21,067 57,844 301.3 149.2 450.5 1,765 3,153 4,918 680 206 885 – 1,093 1,001 2,094 McDaniel’s forecast prices and costs as of January 1, 2014. December 31, 2013 reserves include 10.7 MMBbl of NGLs in the proved developed non-producing ("PDNP") classification which primarily relate to completed wells in the Kaybob COU that will be produced through the Musreau Deep Cut Facility. The PDNP NGLs reserves associated with these wells represent the incremental NGLs volumes that will be extracted from the natural gas stream through deep cut processing. These reserves will be reclassified to proved developed producing ("PDP") reserves when the Musreau Deep Cut Facility enters service. Proved undeveloped reserves totaling 37.7 MMBoe are related to wells in the Kaybob and Grande Prairie COUs that are in the process of being drilled, or are expected to be drilled over the next year. Future development costs totaling $53 million in respect of the estimated costs to complete the Musreau Deep Cut Facility, the Amine Train and the Smoky Deep Cut Facility were deducted in determining the estimated net present value of future net revenue from Paramount’s PDNP reserves. Paramount Resources Ltd. 2013Review of Operations18  The following table summarizes future development costs deducted in the calculation of future net revenue from conventional reserves: Conventional Reserves Total (MBoe) 38,034 11,940 37,703 87,677 46,136 Before Tax NPV0 (1) ($MM) 841 232 692 1,765 1,251 Proved Developed Producing Proved Developed Non-producing Proved Undeveloped Total Proved Total Probable Future Development Costs – Undiscounted Wells & Other ($MM) Plants ($MM) Total ($MM) – 53 – 53 3 – 16 496 512 2 – 69 496 565 5 Total Proved & Probable (1) The estimated net present values disclosed in this document do not represent fair market value. Revenues and expenditures were calculated based on 133,813 3,016 514 56 570 McDaniel’s forecast prices and costs as of January 1, 2014. Reserves Reconciliation(1) Proved Reserves Oil & NGLs (2) (MBbl) Natural Gas (Bcf) Total (MBoe) (3) Proved & Probable Reserves Natural Gas (Bcf) Oil & NGLs (2) (MBbl) Total Conventional Bitumen (MBoe) (3) (MBbl) Total (MBoe) (3) January 1, 2013 Extensions & discoveries Technical revisions Dispositions Production 201.9 124.0 23.5 (9.4) 17,202 18,822 3,267 (657) (38.7) (1,177) 50,857 39,496 7,183 (2,224) (7,634) 323.7 195.1 (15.8) (13.8) (38.7) 32,889 29,986 (1,900) (1,068) (1,177) 86,842 62,507 (4,531) (3,371) (7,634) December 31, 2013 (1) Columns and rows may not add due to rounding. (2) Light and medium crude oil and natural gas liquids. (3) Refer to the Oil and Gas Measures and Definitions and other advisories in the Advisories section of this document. 133,813 93,468 37,457 87,677 58,729 450.5 301.3 93,091 179,933 – 377 – – 62,507 (4,155) (3,371) (7,634) 227,281 Paramount Resources Ltd. 2013Review of Operations19  Finding and Development Costs – Conventional Paramount’s finding and development ("F&D") costs per barrel are summarized below. The total F&D capital includes costs of and changes in future development costs relating to major facilities and gathering system projects. 2013 F&D Cost Including Major Facilities & Gathering 3-Year Average F&D Costs (1)(2) FDC Change (1) Total F&D Capital (1) Reserves Additions (3) $MM $MM $MM MMBoe F&D $/Boe 2012 $/Boe 2011 $/Boe 3-Year Average $/Boe PROVED Kaybob Total Conventional PROVED & PROBABLE Kaybob Total Conventional 485.0 612.8 202.1 315.7 687.1 928.4 485.0 612.8 49.7 163.1 534.8 775.9 37.9 46.7 44.4 58.0 18.14 19.89 12.03 13.38 27.13 29.83 26.73 41.28 22.16 25.77 16.19 19.46 21.28 36.66 14.94 17.22 (1) (2) (3) The aggregate of the exploration and development costs incurred in the most recent financial year and the change during that year in estimated future development costs generally will not reflect total finding and development costs related to reserve additions for that year. Excludes capitalized interest. F&D amounts relate to conventional properties only. Refer to the Oil and Gas Measures and Definitions in the Advisories section of this document. Paramount’s F&D costs per barrel, excluding costs of and changes in future development costs related to major facilities and gathering system projects are summarized below: 2013 F&D Cost Excluding Major Facilities & Gathering 3-Year Average F&D Costs (1)(2) FDC Change (1) Total F&D Capital (1) Reserves Additions (3) $MM $MM $MM MMBoe F&D $/Boe 2012 $/Boe 2011 $/Boe 3-Year Average $/Boe PROVED Kaybob Total Conventional PROVED & PROBABLE Kaybob Total Conventional 347.2 457.8 259.1 372.6 606.2 830.5 347.2 457.8 106.7 172.2 453.9 630.1 37.9 46.7 44.4 58.0 16.01 17.79 10.21 10.87 14.64 16.82 17.85 27.70 15.85 18.86 10.31 12.18 13.57 24.19 10.64 12.81 (1) (2) (3) The aggregate of the exploration and development costs incurred in the most recent financial year and the change during that year in estimated future development costs generally will not reflect total finding and development costs related to reserve additions for that year. Excludes capitalized interest. F&D amounts relate to conventional properties only. Refer to the Oil and Gas Measures and Definitions in the Advisories section of this document. The Kaybob COU’s recycle ratio was 2.0 to 1 in 2013, based on a proved and probable F&D cost of $10.21 per Boe (excluding major facilities and gathering costs). Paramount anticipates that the Kaybob COU’s recycle ratio will increase once the Musreau Deep Cut Facility is on-stream, as higher liquids yields will generate greater per unit netbacks. Paramount Resources Ltd. 2013Review of Operations20  Exploration and Capital Expenditures Year ended December 31 ($ millions) Geological and geophysical Drilling, completion and tie-ins Facilities and gathering Exploration and development expenditures (1) Land and property acquisitions Principal Properties Strategic Investments (2) Corporate 2013 6.3 451.6 167.0 624.9 20.3 645.2 92.3 5.8 743.3 Exploration and development expenditures include $12.1 million of capitalized interest (2012 - $4.6 million). Strategic Investments include $1.0 million of capitalized interest (2012 - $0.4 million). (1) (2) 2012 6.0 304.6 212.5 523.1 25.2 548.3 82.5 0.4 631.2 The Company’s exploration and development expenditures and strategic investments spending, excluding land acquisitions and capitalized interest, totaled $704.1 million in 2013, $95.9 million less than Paramount’s increased 2013 capital budget of $800 million. Planned drilling, completion, tie-in and gathering system projects for the fourth quarter within the Kaybob and Grande Prairie COUs were impacted by site access restrictions caused by unusually heavy snowfall. Completion operations planned for the shale gas exploration well at Dunedin in the fourth quarter were delayed until 2014, as work to prepare the well for completion continued through year-end. Aggregate spending on facilities projects was also lower than expected. Drilling and Land As at December 31 (000’s of acres) Undeveloped land Acreage assigned reserves Total (1) (2) "Gross" acres means the total acreage in which Paramount has an interest. "Net" acres means gross acres multiplied by Paramount’s working interest therein. 2013 2012 Gross(1) Net(2) 1,337 450 1,787 924 249 1,173 Average Working Interest 69% 55% 66% Gross(1) 1,685 523 2,208 Net(2) 1,190 289 1,479 Average Working Interest 71% 55% 67% Wells Drilled by Formation (Net) 12 11 20 Montney Falher Other Paramount Resources Ltd. 2013Review of Operations21  OPERATING RESULTS Paramount’s sales volumes have increased in each of the past five years. The Company is planning for further increases as its Deep Basin expansions startup, with sales volumes expected to reach approximately 50,000 Boe/d in 2014 and increase to approximately 70,000 Boe/d in 2015. In 2013, NGLs were 12 percent of sales volumes but represented 29 percent of total revenue. NGLs are comprising a larger proportion of overall production and revenue, a trend that is expected to continue. NGLs volumes are projected to increase to approximately 40 percent of total sales volumes by the end of 2014. The increases in Company production, together with a higher proportion being NGLs, will generate significantly higher revenue and netbacks. Paramount continues to focus on controlling its operating and general and administrative costs, and per unit costs are projected to decrease as fixed costs are be applied over significantly higher production volumes when the Company’s new facilities start up. Per unit operating costs have also decreased as a result of dispositions of higher-cost properties over the past few years. Average Sales Volumes Sales Revenue Boe/d 25,000 20,000 15,000 10,000 5,000 0 $MM 80 60 40 20 0 % NGLs 15 12 9 6 3 0 $MM 250 200 150 100 50 0 2009 2010 2011 2012 2013 % NGLs 30 24 18 12 6 0 2009 2010 2011 2012 2013 Natural Gas NGLs Crude Oil % NGLs Natural Gas NGLs Crude Oil % NGLs Operating Expense General & Administrative Expense $/Boe 16 12 8 4 0 $MM 20 16 12 8 4 0 $/Boe 5 4 3 2 1 0 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 $/Boe $/Boe Paramount Resources Ltd. 2013Review of Operations22  CORPORATE In May 2013, the Company raised $150.9 million through the issuance of 4.0 million common shares. In October 2013, Paramount raised approximately $60 million through the issuance of 1.4 million CEE flow- through Common Shares. In December 2013, Paramount completed a $150 million re-opening of its 7⅝ percent senior notes due 2019 at a price of $1,007.50 per $1,000 principal amount. The Company’s bank credit facility was increased in 2013 from $300 million to $600 million. The revolving period and maturity date of the credit facility were extended to November 30, 2014 and November 30, 2015, respectively. STRATEGIC INVESTMENTS SHALE GAS Paramount’s shale gas land holdings encompass approximately 200 (167 net) sections in the Liard and Horn River Basins in northeast British Columbia and the Northwest Territories, including approximately 156 net sections with potential from the Besa River shale gas formation. Paramount Resources Ltd. 2013Review of Operations23  The Company finished drilling and completing its first horizontal shale gas exploration well at Patry in northeast British Columbia in the first quarter of 2013 and the well was brought-on production in late- December, following its tie-in to existing third-party infrastructure. Over its first 60 days of production, the well averaged 3.2 MMcf/d of natural gas. The results of the Patry well have been attributed to the well being drilled into a thinner portion of the Besa River shale formation along the eastern-most part of the Liard Basin. At Dunedin, in the central portion of the Liard Basin, the Besa River shale formation is about four times thicker than it is at Patry. Paramount resumed drilling its Dunedin shale gas exploration well at d-57-D in September following the completion of a road to provide all-season access to the wellsite and other area lands. The well was drilled to a total measured depth of 6,000 meters, including a 1,600 meter horizontal leg, with significant pressures noted during drilling operations. While running production casing, the casing hanger packer system prematurely set, resulting in the liner becoming stuck in the wellbore. The Company is currently undertaking recovery operations to remove the liner materials. Following the recovery operation, the Company plans to complete the Dunedin well later in 2014, with tie-in operations to follow in 2015, pending test results from the well. In late-February 2014, Paramount moved an additional rig into Dunedin and has commenced drilling a vertical shale gas exploration well at d-71-G to preserve lands. Cavalier Energy was created in 2011 as a self-funding entity to execute the development of the Company’s oil sands and carbonate bitumen assets. Cavalier Energy holds approximately 200,000 net acres of Crown leases in the Western Athabasca region of Alberta. Hoole Grand Rapids Cavalier Energy’s initial focus is to develop the Grand Rapids formation in its 100 percent owned in-situ oil sands leases in the Hoole area of Alberta (the "Hoole Project"). The Hoole Project is 10 kilometers northeast of Wabasca-Desmarais, Alberta. Since 2004, approximately $80 million has been invested through land acquisitions, stratigraphic drilling, engineering studies, and environmental field programs to bring this asset to the development stage. In November 2012, Cavalier Energy submitted regulatory applications for the initial 10,000 Bbl/d phase of the Hoole Project ("Hoole Phase 1"). During 2013, front-end engineering and design work for Hoole Phase 1 was completed, along with geotechnical work and the drilling of additional delineation wells. Cavalier Energy’s current activities are being funded with drawings on its $40 million credit facility. Construction of Hoole Phase 1 is dependent upon the receipt of regulatory approvals, the securing of funding, and sanctioning by the Board of Directors. Cavalier Energy anticipates that regulatory approvals will be received by mid-2014 and is continuing to evaluate funding alternatives. Cavalier Energy obtained an updated independent evaluation of its Hoole Project, effective December 31, 2013, from the Company’s independent reserves evaluators. The evaluation ascribes 93.5 million barrels of probable undeveloped reserves to Hoole Phase 1 with a net present value of $301 million (before tax, discounted at 10 percent). In addition to these probable undeveloped reserves, the updated evaluation ascribes 746 million barrels of economic contingent resources (best estimate) with a net present value of Paramount Resources Ltd. 2013Review of Operations24  $1.5 billion (before tax, discounted at 10 percent) to Cavalier Energy’s approximately 54 sections of additional Grand Rapids rights at Hoole that are not included in Hoole Phase 1 (the "Remaining Hoole Lands"). Results of the updated evaluation of the Remaining Hoole Lands are as follows: Classification/Level of Certainty (1) DEBIP (1) (MMBbl)(2) Economic Contingent Resources (1) (MMBbl)(2) NPV of Future Net Revenue (3) (before tax, discounted at 10%) ($MM) High Estimate Best Estimate Low Estimate 1,545 1,544 1,533 (1) See Oil Sands Resource Notes in the Advisories section of this document. (2) MMBbl means millions of barrels. (3) NPV of economic contingent resources, see Oil Sands Resource Notes in the Advisories section of this document. 938 746 566 2,512 1,511 446 Fox Drilling, a wholly-owned subsidiary of Paramount, owns five triple-sized rigs in Canada, including two new built-for- purpose walking rigs that were put into service in 2013. Fox Drilling’s rigs are designed to drill the deep horizontal wells that industry is currently focusing on. During 2013, all five rigs were deployed on Paramount has achieved reductions in drilling days and costs from the efficiencies gained by utilizing Fox’s fleet of rigs and maintaining the continuity of rig crews by drilling wells back-to- back. the Company’s Deep Basin lands. The two new walking rigs are both currently drilling separate 10-well pads in the Kaybob COU, and the Company is realizing the benefit of the walking feature of the rigs as the time required to move from well to well is being measured in hours rather than days. Paramount Resources Ltd. 2013Review of Operations25  INVESTMENTS IN OTHER ENTITIES Paramount holds investments in a number of publicly–traded and private corporations as part of its portfolio of strategic investments. The Company’s investments in shares of Trilogy Energy and MGM Energy were principally obtained in the course of the spin-out of the entities from Paramount. Investments in shares of most other entities, including MEG Energy and Strategic Oil & Gas, were received as consideration for properties sold to the entities. Paramount’s investments are summarized below: Market Value (1) As at December 31 Trilogy Energy Corp. MEG Energy Corp. MGM Energy Corp. Strategic Oil & Gas Ltd. Other(2) Shares (000’s) 19,144 3,700 54,147 7,200 2013 $ ($ millions) 528.4 113.3 8.7 5.4 32.7 $ 688.5 ($/share) 27.60 30.61 0.16 0.75 Shares (000’s) 19,144 3,700 54,147 ─ 2012 $ ($ millions) 557.3 112.6 13.5 ─ 21.4 $ 704.8 ($/share) 29.11 30.44 0.25 ─ (1) (2) Based on the period-end closing price of publicly traded investments and book value of remaining investments. Includes investments in other public and private corporations. $MM 1,200 1,000 800 600 400 200 0 Market Value of Investments $/POU Share 18 15 12 9 6 3 0 2009 2010 2011 2012 2013 $/POU Share Paramount Resources Ltd. 2013Review of Operations26  MANAGEMENT’S DISCUSSION & ANALYSIS This Management’s Discussion and Analysis ("MD&A"), dated March 6, 2014, should be read in conjunction with the audited Consolidated Financial Statements of Paramount Resources Ltd. ("Paramount" or the "Company") as at and for the year ended December 31, 2013. Financial data included in this MD&A has been prepared in accordance with International Financial Reporting Standards ("IFRS" or "GAAP") and is stated in millions of Canadian dollars, unless otherwise noted. The Company’s accounting policies have been applied consistently to all periods presented. This document contains forward-looking information, non-GAAP measures and disclosure of certain oil and gas measures. Readers are referred to the Advisories section of this document concerning such matters. Certain comparative figures have been reclassified to conform to the current years’ presentation. Additional information concerning Paramount, including its Annual Information Form, can be found on the SEDAR website at www.sedar.com. ABOUT PARAMOUNT Paramount is an independent, publicly traded, Canadian corporation that explores for and develops conventional petroleum and natural gas prospects, pursues longer-term non-conventional exploration and pre-development projects and holds investments in other entities. The Company’s principal properties are primarily located in Alberta and British Columbia. Paramount’s operations are divided into three business segments, established by management to assist in resource allocation, to assess operating performance and to achieve long-term strategic objectives: i) Principal Properties; ii) Strategic Investments; and iii) Corporate. Paramount’s Principal Properties are divided into four Corporate Operating Units ("COUs"): • • • • the Kaybob COU, which includes properties in west central Alberta; the Grande Prairie COU, which includes properties in the Peace River Arch area of Alberta; the Southern COU, which includes properties in southern Alberta; and the Northern COU, which includes properties in northern Alberta and northeast British Columbia. Strategic Investments include: (i) investments in other entities, including affiliates; (ii) investments in exploration and development stage assets where there is no near-term expectation of commercial production, but a longer-term value proposition based on spin-outs, dispositions or future revenue generation, including oil sands and carbonate interests held by Paramount’s wholly-owned subsidiary Cavalier Energy Inc. ("Cavalier Energy") and prospective shale gas acreage; and (iii) drilling rigs owned by Paramount’s wholly-owned subsidiary Fox Drilling Inc. ("Fox Drilling"). The Corporate segment is comprised of income and expense items, including general and administrative expense and interest expense, which have not been specifically allocated to Principal Properties or Strategic Investments. Paramount Resources Ltd. 2013Management's Discussion & Analysis27  Highlights(1) FINANCIAL Petroleum and natural gas sales – continuing operations Petroleum and natural gas sales – discontinued operations Petroleum and natural gas sales Funds flow from operations – continuing operations Funds flow from operations – discontinued operations Funds flow from operations per share – basic and diluted ($/share) Loss from continuing operations per share – basic and diluted ($/share) Net loss per share – basic and diluted ($/share) Exploration and development expenditures Investments in other entities – market value (2) Total assets Long-term debt Net debt OPERATIONAL Sales volumes (3) Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Net wells drilled (excluding oil sands evaluation) Net oil sands evaluation wells drilled FUNDS FLOW FROM OPERATIONS ($/Boe) (3) Petroleum and natural gas sales Royalties Operating expense and production tax Transportation Netback Financial commodity contract settlements Insurance settlement Netback including commodity contract and insurance settlements General and administrative – corporate General and administrative – strategic investments Interest Dividends from investments Other Funds flow from operations 2013 2012 2011 230.7 1.8 232.5 71.9 (1.3) 70.6 0.75 (87.1) (0.93) (59.1) (0.63) 624.9 688.5 2,447.8 882.6 1,119.2 106.1 2,498 726 20,914 37 6 30.46 (1.42) (9.52) (2.98) 16.54 – – 16.54 (1.66) (0.89) (6.69) 1.05 0.89 9.24 173.4 23.7 197.1 51.9 6.2 58.1 0.67 (64.7) (0.75) (61.9) (0.71) 523.1 704.8 2,037.0 660.7 701.4 98.5 1,873 1,620 19,917 34 1 27.04 (2.27) (9.58) (2.98) 12.21 (0.02) 0.85 13.04 (1.61) (0.88) (4.74) 1.10 1.06 7.97 193.3 48.4 241.7 73.1 23.1 96.2 1.23 (241.9) (3.08) (232.0) (2.96) 465.7 1,077.3 1,725.7 427.2 513.4 81.6 1,542 2,291 17,426 48 27 38.00 (3.47) (11.20) (3.23) 20.10 0.03 – 20.13 (1.90) (0.76) (5.26) 1.79 1.12 15.12 (1) Readers are referred to the advisories concerning non-GAAP measures and Oil and Gas Measures and Definitions in the Advisories section of this document. (2) Based on the period-end closing prices of publicly-traded investments and the book value of the remaining investments. (3) Amounts include the results of discontinued operations. Paramount Resources Ltd. 2013Management's Discussion & Analysis28  Consolidated Results Net Loss Year ended December 31 Principal Properties Strategic Investments Corporate Income tax recovery Loss from continuing operations Discontinued operations, net of tax Net loss 2013 (28.2) 5.3 (82.8) 18.6 (87.1) 28.0 (59.1) 2012 (157.5) 134.0 (65.6) 24.4 (64.7) 2.8 (61.9) 2011 (260.6) 5.1 (61.1) 74.7 (241.9) 9.9 (232.0) Paramount recorded a loss from continuing operations of $87.1 million for the year ended December 31, 2013 compared to a loss from continuing operations of $64.7 million in 2012. Significant factors contributing to the change are shown below: Year ended December 31 Loss from continuing operations – 2012  Lower income from equity-accounted investments mainly due to a $157.2 million gain in 2012 on the sale of 5.0 million shares of Trilogy Energy Corp. ("Trilogy")  Higher interest expense due to increased debt  Lower other income mainly due to a $6.2 million insurance settlement in 2012  Loss on financial commodity contracts in 2013 compared to a gain in 2012  Lower income tax recovery  Lower depletion, depreciation and impairment mainly due to lower impairment write-downs of petroleum and natural gas properties in 2013  Higher netback primarily due to higher realized prices and higher natural gas and NGLs sales volumes  Higher gains on the sale of property, plant and equipment related to continuing operations  Other Loss from continuing operations – 2013 (64.7) (132.0) (17.3) (7.5) (6.5) (5.8) 96.0 44.2 6.3 0.2 (87.1) In March 2013, Paramount sold its Northern COU properties in the Bistcho area of Alberta and the Cameron Hills area of the Northwest Territories (the "Northern Discontinued Operations") for proceeds of $9.1 million. In May 2012, Paramount’s wholly-owned subsidiary, Summit Resources, Inc., closed the sale of all of its operated properties in North Dakota and all of its properties in Montana (the "Southern Discontinued Operations") for after-tax cash proceeds of $66.5 million. These properties were included in the Company’s Principal Properties business segment. Discontinued operations for the year ended December 31, 2013 include the results of the Northern Discontinued Operations. Discontinued operations for the year ended December 31, 2012 include the results of the Northern Discontinued Operations and Southern Discontinued Operations. Paramount Resources Ltd. 2013Management's Discussion & Analysis29  Income from discontinued operations ("IFDO") for the year ended December 31, 2013 of $28.0 million includes a pre-tax loss of $1.6 million from ordinary activities of the Northern Discontinued Operations, a $39.0 million pre-tax gain on the sale of the Northern Discontinued Operations and tax expense of $9.4 million. IFDO for the year ended December 31, 2012 includes a pre-tax loss from ordinary activities of the Northern Discontinued Operations of $36.7 million, pre-tax income from ordinary activities of the Southern Discontinued Operations of $5.0 million, a pre-tax gain of $50.8 million on the sale of the Southern Discontinued Operations, and tax expense of $16.3 million. IFDO for the year ended December 31, 2013 was $25.2 million higher than in 2012, primarily as a result of impairment write-downs related to the Northern Discontinued Operations recorded in 2012. Paramount recorded a loss from continuing operations of $64.7 million for the year ended December 31, 2012 compared to a loss from continuing operations of $241.9 million in 2011. Significant factors contributing to the change are shown below: Year ended December 31 Loss from continuing operations – 2011  Higher income from equity-accounted investments mainly due to a $157.2 million gain on the sale of 5.0 million shares of Trilogy in 2012  Lower depletion, depreciation and impairment mainly due to lower write-downs of petroleum and natural gas properties and goodwill  Higher gains on the sale of property, plant and equipment related to continuing operations  Lower income tax recovery compared to 2011  Lower netback primarily due to a 27 percent decrease in average realized prices  Lower other income, mainly because 2011 included gains related to previous investments in NuLoch Resources Inc. and ProspEx Resources Ltd.  Higher stock-based compensation expense  Higher exploration and evaluation expense mainly due to higher dry hole expense  Other Loss from continuing operations – 2012 (241.9) 152.1 95.8 21.6 (50.4) (22.2) (10.1) (7.6) (6.0) 4.0 (64.7) IFDO for the year ended December 31, 2012 was $2.8 million, $7.1 million lower than in 2011. IFDO in 2012 included a $50.8 million pre-tax gain on the sale of discontinued operations. IFDO for the year ended December 31, 2011 included a $37.2 million pre-tax gain on the sale of undeveloped land. The netback from discontinued operations in 2012 was $16.8 million lower than in 2011 because of a partial year of operations from the Southern Discontinued Operations as a result of their May 2012 sale and lower netbacks in 2012 from the Northern Discontinued Operations. Paramount Resources Ltd. 2013Management's Discussion & Analysis30  Funds Flow from Operations (1) (2) The following is a reconciliation of funds flow from operations to the nearest GAAP measure: Year ended December 31 Cash from operating activities Change in non-cash working capital Geological and geophysical expenses Asset retirement obligations settled Funds flow from operations Funds flow from operations ($/Boe) (1) Refer to the advisories concerning non-GAAP measures in the Advisories section of this document. (2) Includes the results of discontinued operations. 2013 44.9 12.2 7.2 6.3 70.6 9.24 2012 55.2 (12.1) 7.0 8.0 58.1 7.97 2011 84.9 (3.0) 6.8 7.5 96.2 15.12 Year ended December 31 Funds flow from operations Continuing operations Discontinued operations Funds flow from operations 2013 71.9 (1.3) 70.6 2012 2011 51.9 6.2 58.1 73.1 23.1 96.2 Funds flow from operations in 2013 attributable to continuing operations was $71.9 million, $20.0 million higher than 2012. The increase was primarily due to higher netbacks resulting from a 19 percent increase in average realized prices and a 12 percent increase in continuing operations sales volumes, partially offset by higher interest expense and lower other income due to a $6.2 million business interruption insurance settlement received in 2012. Funds flow from operations in 2013 attributable to discontinued operations decreased by $7.5 million compared to the prior year because 2012 included a partial year of operations from the Southern Discontinued Operations as a result of their May 2012 sale. Funds flow from operations in 2012 attributable to continuing operations decreased $21.2 million compared to 2011, primarily because of the impact of a 27 percent decrease in average realized prices, partially offset by higher other income, primarily due to $6.2 million in cash proceeds from a business interruption insurance settlement. Funds flow from operations attributable to discontinued operations in 2012 decreased by $16.9 million compared to 2011 because 2012 includes a partial year of operations from the Southern Discontinued Operations as a result of their May 2012 sale and because of lower netbacks in 2012 from the Northern Discontinued Operations. Paramount Resources Ltd. 2013Management's Discussion & Analysis31  Discontinued Operations Results of the Northern Discontinued Operations have been presented as discontinued operations in the current and prior year. Results of the Southern Discontinued Operations have been presented as discontinued operations in 2012. Comparative results have been adjusted to conform to the current year’s basis of presentation. The Principal Properties section of this Management’s Discussion & Analysis provides an analysis of the results of the Company’s continuing operations. The following tables reconcile Paramount’s loss from continuing operations, income from discontinued operations and net loss: Income (loss) from Continuing Operations ("CO") and Discontinued Operations ("DO") Year ended December 31 2013 2012 Natural gas revenue NGLs revenue Oil revenue Royalty and sulphur revenue Petroleum and natural gas sales Royalties Operating expense Transportation Netback Financial commodity contract settlements Insurance settlement Netback including commodity contract and insurance settlements General and administrative Interest Dividends from investments Other Funds flow from operations DD&A / Accretion Gain on sale of PP&E Stock-based compensation Income from equity-acct. investments Other Income tax (expense) recovery Net income (loss) (1) Natural gas revenue shown per Mcf. CO 137.6 68.1 22.1 2.9 230.7 (10.8) (69.8) (22.6) 127.5 ─ ─ 127.5 (19.5) (51.1) 8.0 7.0 71.9 (156.0) 32.7 (25.9) 21.4 (49.8) 18.6 (87.1) DO ($ millions) 0.7 ─ 1.1 ─ 1.8 ─ (2.9) (0.2) (1.3) ─ ─ (1.3) ─ ─ ─ ─ (1.3) (0.3) 39.0 ─ ─ ─ (9.4) 28.0 Total 138.3 68.1 23.2 2.9 232.5 (10.8) (72.7) (22.8) 126.2 ─ ─ 126.2 (19.5) (51.1) 8.0 7.0 70.6 (156.3) 71.7 (25.9) 21.4 (49.8) 9.2 (59.1) CO Total DO ($/Boe except natural gas)(1) 2.82 3.57 74.73 ─ 87.47 84.75 ─ ─ 3.57 74.73 87.61 ─ 30.44 (1.43) (9.22) (2.97) 16.82 ─ ─ 16.82 (2.57) (6.74) 1.06 0.91 9.48 32.95 ─ (52.54) (4.27) (23.86) ─ ─ (23.86) ─ ─ ─ ─ (23.86) 30.46 (1.42) (9.52) (2.98) 16.54 ─ ─ 16.54 (2.55) (6.69) 1.05 0.89 9.24 CO 93.3 45.3 31.2 3.6 173.4 (14.3) (55.6) (20.2) 83.3 (0.1) 6.2 89.4 (18.1) (34.6) 8.0 7.2 51.9 (251.8) 26.4 (29.1) 153.3 (39.8) 24.4 (64.7) DO ($ millions) Total CO Total DO ($/Boe except natural gas)(1) 2.72 2.74 2.72 67.10 73.20 67.02 83.16 82.30 83.67 – – – 27.04 45.01 25.64 (2.27) (4.27) (2.11) (9.58) (26.96) (8.22) (2.98) (2.99) (2.99) 98.2 46.0 49.3 3.6 197.1 (16.5) (69.9) (21.8) 88.9 12.32 10.79 12.21 – – 10.79 – – – 0.95 11.74 (0.02) 0.85 13.04 (2.49) (4.74) 1.10 1.06 7.97 (0.1) 6.2 (0.02) 0.92 13.22 (2.68) (5.11) 1.19 1.06 7.68 95.0 (18.1) (34.6) 8.0 7.8 58.1 (288.9) 77.2 (29.1) 153.3 (40.6) 8.1 (61.9) 4.9 0.7 18.1 – 23.7 (2.2) (14.3) (1.6) 5.6 – – 5.6 – – – 0.6 6.2 (37.1) 50.8 – – (0.8) (16.3) 2.8 Paramount Resources Ltd. 2013Management's Discussion & Analysis32  Principal Properties Netback and Segment Loss – Continuing Operations Year ended December 31 2013 2012 Petroleum and natural gas sales Royalties Operating expense Transportation Netback Financial commodity contract settlements Insurance settlement Netback including commodity contract and insurance settlements Other principal property items (see below) Segment loss 230.7 (10.8) (69.8) (22.6) 127.5 ─ ─ 127.5 (155.7) (28.2) ($/Boe) 30.44 (1.43) (9.22) (2.97) 16.82 ─ ─ 16.82 ($/Boe) 25.64 (2.11) (8.22) (2.99) 12.32 (0.02) 0.92 13.22 173.4 (14.3) (55.6) (20.2) 83.3 (0.1) 6.2 89.4 (246.9) (157.5) Petroleum and Natural Gas Sales – Continuing Operations Year ended December 31 Natural gas NGLs Oil Royalty and sulphur revenue 2013 137.6 68.1 22.1 2.9 230.7 2012 93.3 45.3 31.2 3.6 173.4 % Change 47 50 (29) (19) 33 Petroleum and natural gas sales in 2013 were $230.7 million, an increase of $57.3 million from the prior year, primarily due to higher realized prices and higher natural gas and NGLs sales volumes, partially offset by lower oil sales volumes. The impact of changes in prices and sales volumes on petroleum and natural gas sales are as follows: Year ended December 31, 2012 Effect of changes in prices Effect of changes in sales volumes Change in royalty and sulphur revenue Year ended December 31, 2013 Natural gas 93.3 32.8 11.5 ─ 137.6 NGLs 45.3 7.0 15.8 ─ 68.1 Oil 31.2 1.0 (10.1) ─ 22.1 Royalty and Sulphur 3.6 ─ ─ (0.7) 2.9 Total 173.4 40.8 17.2 (0.7) 230.7 Paramount Resources Ltd. 2013Management's Discussion & Analysis33  Sales Volumes Natural Gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total (Boe/d) Year ended December 31 Kaybob Grande Prairie Southern Northern Continuing Ops Discontinued Ops Total 2013 72.1 20.0 9.5 3.8 105.4 0.7 106.1 2012 % Change 2013 1,365 21 59.5 809 (4) 20.9 255 (2) 9.7 67 9 3.5 2012 % Change 2013 29 48 322 8 342 61 ─ 294 924 749 158 17 2012 % Change 2013 (53) 5 (47) ─ 62 307 647 ─ 13,402 10,910 4,536 4,459 2,419 2,179 609 725 93.6 4.9 98.5 13 (86) 8 2,496 1,848 2 2,498 25 1,873 35 (92) 33 693 33 726 1,016 604 1,620 (32) (95) (55) 20,765 18,474 149 1,443 20,914 19,917 23 (2) (10) 19 12 (90) 5 2012 % Change Natural gas sales volumes increased 11.8 MMcf/d or 13 percent to 105.4 MMcf/d in 2013 compared to 93.6 MMcf/d in 2012. NGLs sales volumes increased 648 Bbl/d or 35 percent to 2,496 Bbl/d in 2013 compared to 1,848 Bbl/d in 2012. The Company’s 45 MMcf/d natural gas refrigeration processing facility (the "Musreau Refrig Facility") was re-commissioned in March 2012, allowing the Company to begin producing incremental volumes that had been shut-in because of limited processing capacity. Increases in natural gas and NGLs sales volumes were primarily related to new well production from the Company’s 2012 / 2013 drilling program at Musreau and Smoky within the Kaybob COU, including liquids-rich Montney wells. The increase in NGLs sales includes an increase in condensate volumes, which comprised 64 percent of total NGLs sales in 2013 (2012 – 57 percent). Oil sales volumes decreased 32 percent to 693 Bbl/d in 2013 compared to 1,016 Bbl/d in 2012. The decrease in oil sales volumes is primarily due to the sale of properties in the Southern COU. In 2013, Paramount’s production within the Kaybob COU continued to be constrained by available owned and contracted natural gas processing capacity, pending completion of the new and expanded deep cut facilities at Musreau and Smoky. The constraints are expected to abate in 2014 following startup of the Musreau Deep Cut Facility and the completion of expansions to third-party downstream NGLs facilities, which will allow the Company to bring wells on production that have been shut-in on a temporary basis awaiting additional processing capacity. The ability of Paramount to maximize production through Company-owned and third-party facilities in 2013 was impacted by various third-party downstream disruptions and capacity constraints ("Third-Party Disruptions") in the Kaybob and Grande Prairie COUs. The Third-Party Disruptions mainly related to apportionments of transportation and processing capacity and down-time because of maintenance at third-party natural gas processing facilities. The trucking of condensate production from well sites, which partially mitigated NGLs pipeline constraints, was temporarily suspended between May and August due to spring road bans and heavy rainfall. As a result, the Company estimates that average sales volumes were curtailed by approximately 3,500 Boe/d during 2013. Paramount’s operations were also impacted by the temporary shut-in of multi-well pads to bring new wells on production and maintenance downtime at Company-owned facilities. Paramount Resources Ltd. 2013Management's Discussion & Analysis34  Average Realized Prices – Continuing Operations Year ended December 31 Natural gas ($/Mcf) NGLs ($/Bbl) Oil ($/Bbl) Total ($/Boe) 2013 3.57 74.73 87.61 30.44 2012 2.72 67.02 83.67 25.64 % Change 31 12 5 19 Paramount’s average realized price for natural gas increased 31 percent in 2013 compared to the prior year, consistent with increases in benchmark AECO natural gas prices. Paramount’s natural gas portfolio primarily consists of sales priced at the Alberta spot market and California market and is sold in a combination of daily and monthly contracts. Paramount’s NGLs and oil sales portfolio primarily consists of sales priced relative to Alberta and United States market indexes, adjusted for transportation and quality differentials. Commodity Prices Key monthly average commodity price benchmarks and foreign exchange rates are as follows: Natural Gas AECO daily spot (CDN$/GJ) AECO monthly index (CDN$/GJ) NYMEX (Henry Hub – US$/MMbtu) Crude Oil Edmonton par (CDN$/Bbl) West Texas Intermediate (US$/Bbl) Foreign Exchange $CDN / 1 $US Commodity Price Management 2013 2012 % Change 3.13 3.00 3.68 93.24 97.98 2.43 2.28 2.80 86.53 94.19 1.03 1.00 29 32 31 8 4 3 From time-to-time Paramount uses financial and physical commodity price contracts to manage exposure to commodity price volatility. Paramount has not designated any of its financial commodity contracts as hedges and, as a result, changes in the fair value of these contracts are recognized in earnings. Payments on the settlement of financial commodity contracts are as follows: Year ended December 31 Oil Contracts 2013 ─ 2012 (0.1) Paramount Resources Ltd. 2013Management's Discussion & Analysis35  At December 31, 2013, Paramount had the following financial commodity contracts outstanding: Instrument Oil – NYMEX WTI Swap Oil – NYMEX WTI Swap Total Notional 1,000 Bbl/d 2,000 Bbl/d Average Fixed Price US $92.43/Bbl US $91.78/Bbl Fair Value (1.0) (3.0) (4.0) Remaining Term January – June 2014 January – December 2014 Subsequent to December 31, 2013, the Company entered into the following financial commodity sales contracts: Instrument Natural Gas – AECO Swap Total Notional 20,000 GJ/d Average Fixed Price CAD$4.45/GJ Remaining Term April – October 2014 Royalties – Continuing Operations Year ended December 31 Royalties 2013 10.8 Rate 4.7% 2012 14.3 Rate 8.4% Royalties decreased $3.5 million to $10.8 million in 2013 compared to $14.3 million in 2012, primarily as a result of a greater proportion of production qualifying for Alberta new well royalty incentive programs, partially offset by the impact of higher revenues. Royalties for the year ended December 31, 2013 also decreased $2.7 million as a result of annual gas cost allowance adjustments related to 2012. Excluding the impact of the gas cost allowance adjustments, Paramount’s 2013 royalty rate decreased to six percent. Operating Expense – Continuing Operations Year ended December 31 Operating expense 2013 69.8 2012 55.6 % Change 26 Operating expense increased $14.2 million or 26 percent in 2013 to $69.8 million compared to $55.6 million in 2012, primarily related to higher production from new wells at Musreau and Smoky within the Kaybob COU and at Birch in the Northern COU, and higher costs within the Grande Prairie COU including well maintenance, temporary equipment rentals, and the impact of third-party processing facility equalizations. Paramount’s operating expenses were $9.22 per Boe in 2013 compared to $8.22 per Boe in 2012, mainly because of higher costs within the Grande Prairie COU including well maintenance, temporary equipment rentals and the impact of third-party processing facility equalizations. Paramount’s per unit operating costs are expected to decrease in 2014 as a higher proportion of its production will be from its lower cost Kaybob properties. Paramount Resources Ltd. 2013Management's Discussion & Analysis36  Transportation – Continuing Operations Year ended December 31 Transportation 2013 22.6 2012 20.2 % Change 12 Transportation expense was $22.6 million in 2013, an increase of $2.4 million compared to 2012, primarily due to higher variable transportation costs related to higher sales volumes including the additional cost of trucking condensate from well sites in 2013. The increase in variable costs was partially offset by the expiry of a long-term natural gas transportation export agreement in the fourth quarter of 2012, which reduced current year fixed transportation costs. Transportation per Boe was $2.97 in 2013 and $2.99 per Boe in 2012. Other Principal Property Items – Continuing Operations Year ended December 31 Commodity contracts – net of settlements Depletion and depreciation (excluding impairment) Impairment Exploration and evaluation Gain on sale of property, plant and equipment Accretion of asset retirement obligations Other Total 2013 4.0 144.1 6.5 34.7 (32.3) 3.1 (4.4) 155.7 2012 (2.6) 140.7 106.1 31.5 (26.4) 2.9 (5.3) 246.9 Depletion and depreciation expense (excluding impairment) increased to $144.1 million ($19.01 per Boe) in 2013 compared to $140.7 million ($20.81 per Boe) in 2012, mainly due to higher production volumes. The Company recorded a net impairment write-down of its petroleum and natural gas assets totaling $6.5 million in 2013 (2012 – $106.1 million), comprised of write-downs totaling $37.3 million in the Southern and Northern cash generating units ("CGU"), net of an impairment reversal of $30.8 million in respect of the Grande Prairie CGU. The impairment write-downs in the Southern and Northern CGUs were recorded because the carrying value of their properties exceeded their recoverable amounts, which were estimated based on expected discounted cash flows from the production of proved and probable reserves. The impairments resulted from a combination of declines in reserves assigned due to well performance and, in the Southern CGU, the sale of properties with recoverable amounts that exceeded their carrying values. The reversal of previously recorded impairment write-downs in the Grande Prairie CGU resulted from increases in reserves assigned to the CGU due to recent drilling programs. The reversal was recorded to the extent that the recoverable amount ascribed to the Grande Prairie CGU exceeded the carrying value of its properties. Exploration and evaluation expense includes the cost of expired undeveloped land leases, geological and geophysical costs and dry hole expense. Exploration and evaluation expense included expired lease costs of $14.4 million ($18.7 million – 2012) and dry hole expense of $14.0 million ($6.4 million – 2012), primarily from exploratory wells in the Grande Prairie and Southern COUs. Paramount Resources Ltd. 2013Management's Discussion & Analysis37  The gain on sale of property, plant and equipment of $32.3 million recorded in 2013 relate primarily to the sale of lands in the Ante Creek area of Alberta and the sale of non-core properties in the Southern COU. In February 2014, Paramount entered into an agreement to sell its properties in the Chain-Delia area within the Southern COU for approximately $12 million in shares of a TSX Venture Exchange listed company. The properties had average 2013 production of approximately 6 MMcf/d of natural gas. The transaction is scheduled to close in the first quarter of 2014. Strategic Investments Year ended December 31 Income from equity–accounted investments Drilling rig revenue Drilling rig expense General and administrative Stock-based compensation Interest Other Segment income 2013 21.4 4.2 (1.9) (6.8) (7.2) (2.4) (2.0) 5.3 2012 153.3 7.5 (4.7) (6.4) (10.9) (1.5) (3.3) 134.0 Income from equity-accounted investments in 2013 includes a $25.7 million dilution gain, partially offset by $4.3 million of equity losses. In 2012, Paramount closed the sale of 5.0 million of its Trilogy shares for net cash proceeds of $181.7 million, recognizing a gain of $157.2 million. Strategic Investments at December 31, 2013 include:     investments in the shares of Trilogy, MEG Energy Corp. ("MEG"), MGM Energy Corp. ("MGM Energy"), Strategic Oil & Gas Ltd. ("Strategic") and other public and private corporations; oil sands and carbonate interests owned by Paramount’s wholly-owned subsidiary, Cavalier Energy, including oil sands reserves and resources at Hoole, situated within the western portion of the Athabasca Oil Sands region, and carbonate bitumen holdings in Northeast Alberta, including at Saleski; prospective shale gas acreage in the Liard and Horn River Basins in Northeast British Columbia and the Northwest Territories; and five drilling rigs owned by Paramount’s wholly-owned subsidiary, Fox Drilling. Paramount Resources Ltd. 2013Management's Discussion & Analysis38  Investments Paramount holds investments in a number of publicly-traded and private corporations as part of its portfolio of strategic investments. The Company’s investment in shares of Trilogy and MGM Energy were principally obtained in the course of the spin-out of the entities from Paramount. Investments in shares of most other entities, including MEG, were received as consideration for properties sold to the entities. Paramount’s investments are summarized as follows: Carrying Value Market Value (1) As at December 31 Trilogy MEG MGM Energy Strategic Other (2) Total (1) Based on the period-end closing price of publicly traded investments and the book value of remaining investments. (2) Includes investments in other public and private corporations. 2013 528.4 113.3 8.7 5.4 32.7 688.5 2012 82.4 112.6 2.3 ─ 21.4 218.7 2013 97.4 113.3 1.2 5.4 32.7 250.0 2012 557.3 112.6 13.5 ─ 21.4 704.8 Cavalier Energy In November 2012, Cavalier Energy submitted regulatory applications for the initial 10,000 Bbl/d phase of the Hoole Grand Rapids development ("Hoole Grand Rapids Phase 1"). During 2013, Cavalier Energy completed front-end engineering and design work for Hoole Grand Rapids Phase 1, along with geotechnical work and the drilling of additional delineation wells. Cavalier Energy’s current activities are being funded with drawings on its $40 million credit facility. Construction of Hoole Grand Rapids Phase 1 is dependent upon the receipt of regulatory approvals, securing funding, and sanctioning by the Board of Directors. Cavalier Energy anticipates regulatory approvals will be received by mid-2014 and is continuing to evaluate funding alternatives. Shale Gas The Company finished drilling and completing its first horizontal shale gas exploration well at Patry in northeast British Columbia in the first quarter of 2013 and the well was brought-on production in late- December, following its tie-in to existing third-party infrastructure. Over its first 60 days of production, the well averaged 3.2 MMcf/d of natural gas. The results of the Patry well have been attributed to the well being drilled into a thinner portion of the Besa River shale formation along the eastern-most part of the Liard Basin. At Dunedin, in the central portion of the Liard Basin, the Besa River shale formation is about four times thicker than it is at Patry. Paramount resumed drilling its Dunedin shale gas exploration well at d-57-D in September following the completion of a road to provide all-season access to the wellsite and other area lands. The well was drilled to a total measured depth of 6,000 meters, including a 1,600 meter horizontal leg. While running production casing, the casing hanger packer system prematurely set, resulting in the liner becoming stuck in the wellbore. The Company is currently undertaking recovery operations to remove the liner materials. Following the recovery operation, the Company plans to complete the Dunedin well later in 2014, with tie-in operations to follow in 2015, pending test results from the well. In Paramount Resources Ltd. 2013Management's Discussion & Analysis39  late-February 2014, Paramount moved an additional rig into Dunedin and has commenced drilling a vertical shale gas exploration well at d-71-G to preserve lands. Fox Drilling Fox Drilling owns five triple-sized rigs in Canada, including two new built-for-purpose walking rigs that were put into service in 2013. Fox Drilling’s rigs are designed to drill the deep horizontal wells that the industry is currently focusing on. During 2013, all five rigs were deployed on the Company’s Deep Basin lands. When the drilling rigs drill on a property owned by Paramount, the Company capitalizes its working interest share of the drilling expenses and eliminates the associated drilling revenue. Drilling rig revenue and drilling rig expense above relate to the working interest share of joint venture partners in such amounts. Corporate Year ended December 31 Interest General and administrative Stock-based compensation Depreciation Foreign exchange Segment loss 2013 50.2 12.7 18.7 0.7 0.5 82.8 2012 33.8 11.7 18.2 0.3 1.6 65.6 The Corporate segment loss increased to $82.8 million in 2013 compared to $65.6 million in 2012, primarily as a result of higher interest expense as a result of higher 2013 debt levels. Paramount’s 2013 corporate general and administrative costs were $12.7 million compared to $11.7 million in 2012. Taxes Based on the current tax regime, and the Company’s available tax pools and anticipated level of operations, Paramount does not expect to be cash taxable in the near future. At December 31, 2013, Paramount’s income tax pools are as follows: As at December 31 Canadian oil and gas property expense Canadian development expense Canadian exploration expense Undepreciated capital cost Non-capital losses Financing costs and other Total federal tax pools 2013 174.0 453.3 398.6 638.0 601.5 29.0 2,294.4 Paramount Resources Ltd. 2013Management's Discussion & Analysis40  Exploration and Capital Expenditures Year ended December 31 Geological and geophysical Drilling, completion and tie-ins Facilities and gathering Exploration and development expenditures (1) Land and property acquisitions Principal Properties Strategic Investments (2) Corporate 2013 6.3 451.6 167.0 624.9 20.3 645.2 92.3 5.8 743.3 2012 6.0 304.6 212.5 523.1 25.2 548.3 82.5 0.4 631.2 (1) Exploration and development expenditures include $12.1 million of capitalized interest (2012 - $4.6 million). (2) Strategic Investments include $1.0 million of capitalized interest (2012 - $0.4 million). Exploration and development ("E&D") expenditures in 2013 were $624.9 million compared to $523.1 million in 2012. Current year drilling, completion and tie-in costs were focused on new wells at Musreau, Smoky and Resthaven in the Kaybob COU where advance drilling is continuing for the new and expanded deep cut facilities. The Company also drilled and completed wells at Karr-Gold Creek in the Grande Prairie COU. Facilities and gathering expenditures focused on the new and expanded deep cut facilities at Musreau and Smoky. Strategic investments capital expenditures for 2013 included $57.5 million related to the Company’s exploratory shale gas drilling activities at Dunedin and Patry in Northeast British Columbia, $17.6 million related to completing the construction of two triple-sized walking drilling rigs and re-certifying an existing rig, and $17.2 million related to front-end engineering and design, geotechnical work, and the drilling of additional delineation wells in Cavalier Energy. The Company’s E&D and strategic investments spending, excluding land acquisitions and capitalized interest, totaled $704.1 million in 2013, $95.9 million less than Paramount’s increased 2013 capital budget of $800 million. Planned drilling, completion, tie-in and gathering system projects for the fourth quarter within the Kaybob and Grande Prairie COUs were impacted by site access restrictions caused by unusually heavy snowfall. Completion operations planned for the shale gas exploration well at Dunedin in the fourth quarter were delayed until 2014, as work to prepare the well for completion continued through year-end. Aggregate spending on facilities projects was also lower than expected. Wells drilled were as follows: 2013 2012 Gross (1) Net (2) Gross (1) Net (2) Natural gas 34 Oil – Oil sands evaluation 1 Total 35 (1) Gross is the number of wells in which Paramount has a working interest or a royalty interest that may be converted to a working interest. (2) Net is the aggregate number of wells obtained by multiplying each gross well by Paramount’s percentage of working interest. 35 2 6 43 44 1 1 46 44 3 6 53 Paramount Resources Ltd. 2013Management's Discussion & Analysis41  Kaybob Deep Basin Development The Musreau Deep Cut Facility is scheduled to startup in the second quarter of 2014. Mechanical construction is substantially complete and activities at the site are focused on completing the final stages of the electrical and instrumentation work. Commissioning of individual components of the facility commenced in December 2013. Activities at the site were impacted by third-party labour shortages and severe weather conditions in late-January and February 2014 which have prolonged the remaining work and the commissioning process. As a result of these changes, the Company is accelerating work originally planned for later in the year to integrate the amine processing train and the condensate stabilizer expansion to minimize downtime later in 2014 when these additional components are started- up. The expected total cost of the facility remains at approximately $190 million, in-line with the original budget. The Company continues to advance the construction of the amine processing train at the Musreau Deep Cut Facility site, which will provide the capability to treat sour gas production at the facility instead of at well sites. This project is expected to cost approximately $45 million, will reduce equipping costs per well by over $1 million and result in lower ongoing well operating costs. Major components for the amine processing train are being delivered to the plant site, with construction and installation activities scheduled to be completed in the fourth quarter of 2014. Condensate yields from Paramount’s new Montney wells at Musreau exceeded expectations in 2012. As a result, the Company initiated a project to expand the condensate stabilizer system servicing the Musreau Deep Cut Facility and the Musreau Refrig Facility by 15,000 Bbl/d to process the anticipated incremental liquids volumes (the "Stabilizer Expansion"). Long-lead time components have been ordered and the project is expected to be completed in the fourth quarter of 2014 at a cost of approximately $45 million. Upon start-up of the Musreau Deep Cut Facility, the Kaybob COU will have condensate stabilization capacity of approximately 8,500 Bbl/d, which will increase to approximately 23,500 Bbl/d when the Stabilizer Expansion becomes operational. Until the Stabilizer Expansion is completed, Kaybob field condensate production in excess of capacity will be trucked to other Paramount and third-party facilities for processing. Site work on the non-operated Smoky deep cut facility expansion (the "Smoky Deep Cut Facility") continues, with process equipment delivered and mechanical work underway. The expansion is scheduled to be commissioned in the third quarter of 2014. Paramount was advised by the third-party operator that it expects the existing Smoky 100 MMcf/d dew-point facility will be shut-down for approximately two months commencing in the second quarter of 2014 to complete its integration with the expansion. Paramount’s share of the Smoky Deep Cut Facility expansion costs is expected to total $75 million, of which approximately $50 million has been incurred to December 31, 2013. Paramount is continuing the preliminary planning for construction of additional natural gas processing facilities in the Deep Basin. The specific location, capacity and construction timeline of proposed new facilities are currently under review. A decision to proceed is anticipated later in 2014 following the ramp- up of the Musreau Deep Cut Facility and obtaining additional well performance data, including NGLs yields. Paramount completed the drilling of 31 (26.2 net) wells in the Kaybob COU in 2013, including 13 (12.3 net) Montney wells and 16 (11.9 net) Falher wells. The majority of these new wells have been completed and tied-in and will be brought-on production when the Musreau Deep Cut Facility commences operation. The 2013 drilling program included six pad sites that accounted for 19 of the 31 wells drilled. In addition, Paramount Resources Ltd. 2013Management's Discussion & Analysis42  Paramount’s two walking drilling rigs are each drilling 10-well Montney pads, which are expected to be finished drilling in the second quarter of 2014. As of February 28, 2014, the Company’s behind pipe well inventory in the Kaybob Deep Basin was 66 (47.9 net) wells, including wells previously produced that have been temporarily shut-in due to capacity constraints. Production from these wells will be processed through the Musreau and Smoky deep cut facilities and Paramount’s other Kaybob area capacity. Kaybob COU sales volumes will start to increase in the second quarter of 2014 as the Musreau Deep Cut Facility starts up and will increase further as the Company’s other infrastructure projects are completed and additional third-party NGLs processing capacity becomes available. The precise timing of the increases will depend upon the Company’s working interest in wells processed through its facilities, the liquids content of the wells brought-on production and the period in which third-party de-ethanization capacity becomes available, among other factors. Outlook The Company’s 2014 exploration and development ("E&D") and strategic investments capital budget is $650 million, excluding land acquisitions and capitalized interest. Paramount’s E&D investments will primarily focus on the Company’s Deep Basin developments, including drilling and completing wells in Kaybob to feed the new deep cut facilities and at Karr-Gold Creek to further delineate the middle and upper Montney formation. Spending will also be directed to facilities projects including completion of the deep cut projects at Musreau and at Smoky, the amine processing train and the condensate stabilizer expansion. In the Southern and Northern COUs, up to eight wells are planned to be drilled to explore new opportunities and for land retention. Strategic Investments spending in 2014 will be directed towards completing the d-57-D shale gas exploration well at Dunedin and drilling an additional vertical shale gas exploration well at Dunedin for land retention. Fourth quarter 2013 sales volumes averaged approximately 20,000 Boe/d and Paramount expects sales volumes to continue at that level, after giving effect to the first quarter Chain area disposition. Paramount will begin to ramp-up production as the Musreau Deep Cut Facility starts up, additional components of the Company’s Kaybob area infrastructure are completed and third-party de-ethanization capacity becomes available. Sales volumes are expected to reach approximately 50,000 Boe/d in 2014 and increase to approximately 70,000 Boe/d in 2015, depending upon the availability of downstream third-party de- ethanization capacity. Liquidity and Capital Resources Paramount manages its capital structure to support current and future business plans and periodically adjusts the structure in response to changes in economic conditions and the risk characteristics of the Company’s underlying assets and operations. Paramount may adjust its capital structure by issuing or repurchasing shares, altering debt levels, modifying capital programs, acquiring or disposing of assets or participating in joint ventures. Paramount Resources Ltd. 2013Management's Discussion & Analysis43  2012 % Change As at December 31 Adjusted working capital deficit (surplus) (1) Demand facilities Credit facility Senior Notes (2) Net debt (3) Share capital Accumulated deficit Reserves Total Capital (1) Adjusted working capital excludes risk management assets and liabilities, demand facilities, assets and liabilities held for sale, and accounts payable and accrued liabilities relating to the Company’s obligation to renounce qualifying expenditures for flow-through share issuances (December 31, 2013 – $9.5 million, December 31, 2012 – $10.8 million). (2) Excludes unamortized issue premiums and financing costs. (3) Net debt excludes the $20 million deposit on account with the CRA, pending resolution of the Company’s notices of objection. NM – Not meaningful. 2013 151.8 75.6 71.8 820.0 1,119.2 1,169.2 (224.6) 87.6 2,151.4 (9.3) 40.7 ─ 670.0 701.4 921.7 (165.5) 94.9 1,552.5 NM 86 100 22 60 27 (36) (8) 39 Paramount had an adjusted working capital deficit at December 31, 2013 of $151.8 million compared to a surplus of $9.3 million at December 31, 2012. The adjusted working capital deficit at December 31, 2013 included $10.7 million of cash and cash equivalents, $39.3 million of accounts receivable and $204.0 million of accounts payable and accrued liabilities. The change in adjusted working capital is primarily due to capital spending related to the Company’s 2013 capital program, partially offset by proceeds from equity issuances, the December 2013 senior notes offering, funds flow from operations, drawings on credit facilities, and proceeds from the sale of non-core properties. Paramount raised approximately $420 million in aggregate cash proceeds in 2013 through financing transactions, the sale of non-core oil and gas properties and the sale of investments (the "2013 Transactions"). These transactions included the public offering and private placement of 5.4 million Common Shares, of which 1.4 million Common Shares were issued on a “flow-through” basis, and the public offering of $150 million aggregate principal amount of additional 2019 senior notes. Proceeds from the 2013 Transactions were used, and are expected to be used, to further the development and exploration of Paramount’s properties, including drilling and completion work on properties within the Kaybob, Grande Prairie and northeast British Columbia areas, and the construction and expansion of the Company’s Kaybob natural gas processing and associated facilities. Proceeds from Common Shares issued on a “flow-through” basis were used, and are expected to be used, to incur eligible Canadian Exploration Expenses. Paramount raised approximately $710 million in aggregate cash proceeds in 2012 through financing transactions, the sale of investments and the sale of non-core oil and gas properties (the “2012 Transactions”). These transactions included a public offering of $300 million aggregate principal amount of 2019 senior notes, public offerings and private placements of 4.2 million Common Shares issued on a “flow-through” basis, and the sale of a portion of the Company’s investment in Trilogy for $181.7 million. Proceeds from the 2012 Transactions were used for drilling and completion work within the Kaybob, Grande Prairie and northeast British Columbia areas, and facilities construction within the Kaybob and Grand Prairie areas. Paramount incurred sufficient qualifying expenditures to satisfy commitments associated with flow-through Common Shares issued in 2012. Paramount expects to fund its 2014 operations, obligations and capital expenditures with funds flow from operations, drawings on its bank credit facilities, existing cash and cash equivalents and by accessing the capital markets, if required. The Company’s bank credit facility was increased to $600 million in November 2013, of which $71.8 million was drawn as of December 31, 2013. As production constraints Paramount Resources Ltd. 2013Management's Discussion & Analysis44  within the Kaybob COU begin to abate in 2014, funds flow from operations is expected to increase because of higher sales volumes. Demand Facilities Drilling Rig Facilities In 2013, Fox Drilling repaid and replaced demand loans previously outstanding with a new $57.0 million non-revolving demand loan facility (the "Drilling Rig Facility"). The Drilling Rig Facility was drawn in full at closing and principal payments of $4.0 million were made to December 31, 2013. In connection with the Drilling Rig Facility, an $8.0 million non-revolving demand loan facility was entered into in order to fund the purchase of auxiliary equipment for the drilling rigs (the "Auxiliary Equipment Loan"), which was undrawn at December 31, 2013. Recourse and security for the Drilling Rig Facility and Auxiliary Equipment Loan (collectively, the "Drilling Rig Facilities") is limited to drilling rigs owned by Fox Drilling and drilling contracts guaranteed by Paramount. Interest on the Drilling Rig Facilities is payable at the bank's prime lending rate or bankers' acceptance rate, as selected at the discretion of the Company, plus an applicable margin. Scheduled principal repayments are $8.0 million annually from 2014 to 2017, with the remaining outstanding balance payable in 2018. Cavalier Facility Cavalier Energy has a $40.0 million demand loan facility with a syndicate of Canadian banks (the "Cavalier Facility"). Drawings on the Cavalier Facility bear interest at the lenders’ prime lending rates, US base rates, or bankers’ acceptances rates, as selected at the discretion of Cavalier Energy, plus an applicable margin. The Cavalier Facility is non-recourse to Paramount and is secured by all of the assets of Cavalier Energy, including oil sands and carbonate bitumen lands. At December 31, 2013, $22.6 million was drawn on the Cavalier Facility. Bank Credit Facility Paramount’s bank credit facility (the "Facility") was increased in 2013 from $300 million to $600 million, which is available in two tranches. The first tranche ("Tranche A") has a credit limit and lender commitments of $500 million and is available on a revolving basis to November 30, 2014. In the event the revolving period is not extended, Tranche A would be available on a non-revolving basis for an additional year, at which time it would be due and payable. The second tranche ("Tranche B") is available on a revolving basis, has a credit limit of up to $100 million and is due November 30, 2014 in the event the due date is not earlier extended. The Facility is secured by a first fixed and floating charge over substantially all of the assets of Paramount, excluding assets securing the Drilling Rig Facilities and the Cavalier Facility. Balances drawn under Tranche B are secured by the pledge of certain of the Company’s equity investments from time-to-time. Borrowings under the Facility bear interest at the lenders’ prime lending rates, US base rates, bankers’ acceptance rates or LIBOR rates, as selected at the discretion of Paramount, plus an applicable margin which is dependent upon the Company’s debt-to-cash flow ratio, the tranche under which borrowings are made and the total amount drawn. The maximum amount that Paramount may borrow under the Facility is subject to periodic review and is dependent upon the Company’s reserves, lenders’ projections of future commodity prices, the value attributed by lenders to Paramount's other property and the market value of equity investments pledged by Paramount from time-to-time under Tranche B, among other factors. As at December 31, 2013, $71.8 million was drawn on Tranche A and Tranche B was undrawn. Paramount Resources Ltd. 2013Management's Discussion & Analysis45  Paramount had undrawn letters of credit outstanding at December 31, 2013 totaling $44.7 million that reduce the amount available to the Company. Senior Notes Paramount has $370 million aggregate principal amount of senior unsecured notes due 2017 (the "2017 Senior Notes") outstanding. The 2017 Senior Notes bear interest at 8.25 percent per annum, payable semi-annually in arrears on June 13 and December 13 in each year and mature on December 13, 2017. The 2017 Senior Notes are direct senior unsecured obligations of Paramount and rank equally with all other senior unsecured indebtedness of the Company. The Company has the right to redeem all or a portion of the 2017 Senior Notes at par, plus accrued and unpaid interest to the date of redemption, plus a redemption premium, if applicable, which varies based on the date of redemption. In December 2012, Paramount completed a public offering of $300 million aggregate principal amount of senior unsecured notes due 2019 (the "2019 Senior Notes") at par. In December 2013, Paramount completed a $150 million re-opening of the 2019 Senior Notes at a price of $1,007.50 per $1,000 principal amount. Certain officers, management and associates of the Company purchased an aggregate $17.9 million principal amount of 2019 Senior Notes under the two offerings. The 2019 Senior Notes bear interest at 7.625 percent per annum, payable semi-annually in arrears on June 4 and December 4 in each year and mature on December 4, 2019. The 2019 Senior Notes are direct senior unsecured obligations of Paramount and rank equally with all other senior unsecured indebtedness of the Company. The Company has the right to redeem all or a portion of the 2019 Senior Notes at par, plus accrued and unpaid interest to the date of redemption, plus a redemption premium, if applicable, which varies based on the date of redemption. Share Capital In October 2013, Paramount issued 1,115,000 Common Shares on a "flow-through" basis in respect of Canadian exploration expenses (the "FTS") at a price of $44.00 per share for gross proceeds of $49.1 million, pursuant to a public offering. Concurrent with the public offering, Paramount issued FTS at a price of $44.00 per share to the Company’s Chairman and Chief Executive Officer and President and Chief Operating Officer and/or companies controlled by them for gross proceeds of approximately $10 million, and to certain other directors, officers, and employees of Paramount and other persons for gross proceeds of approximately $1 million. In May 2013, Paramount issued 4,025,000 Common Shares at a price of $37.50 per share for gross proceeds of $150.9 million pursuant to a public offering. In October 2012, Paramount issued 1,936,000 Common Shares on a "flow-through" basis in respect of Canadian exploration expenses ("CEE") at a price of $31.00 per share and 356,000 Common Shares on a "flow-through" basis in respect of Canadian development expenses ("CDE") at a price of $28.15 per share for aggregate gross proceeds of $70 million, pursuant to a public offering. Certain officers and management of the Company participated in this offering. In September 2012, Paramount issued 646,000 Common Shares on a "flow-through" basis in respect of CEE at a price of $31.00 per share and 1,244,000 Common Shares on a "flow-through" basis in respect of CDE at a price of $28.15 per share to a company controlled by the Company’s Chairman and Chief Executive Officer for aggregate proceeds of $55 million. Paramount Resources Ltd. 2013Management's Discussion & Analysis46  The Company is committed to incur $59.8 million of qualifying expenditures related to the 2013 offerings of FTS by December 31, 2014, of which $11.2 million was incurred as of December 31, 2013. Paramount has incurred sufficient qualifying expenditures to satisfy commitments associated with the CEE and CDE flow-through Common Shares issued in 2012. At March 4, 2014, Paramount had 97,501,874 Common Shares and 6,188,450 Paramount Options outstanding, of which 1,973,000 Paramount Options are exercisable. Quarterly Information Operating Results – Continuing Operations Netback – Continuing Operations Three months ended December 31 2013 2012 Natural gas NGLs Oil Royalty and sulphur revenue Petroleum and natural gas sales Royalties Operating expense Transportation Netback Financial commodity contract settlements Netback including financial commodity contract settlements (1) Natural gas revenue shown per Mcf. ($/Boe) (1) 3.73 74.30 78.92 – 30.99 (1.50) (10.19) (3.60) 15.70 – 15.70 35.1 18.2 3.9 0.6 57.8 (2.8) (19.0) (6.7) 29.3 – 29.3 31.6 11.8 6.9 0.7 51.0 (4.4) (15.6) (5.2) 25.8 0.7 26.5 ($/Boe) (1) 3.45 61.14 79.20 – 28.27 (2.45) (8.63) (2.86) 14.33 0.40 14.73 Fourth quarter 2013 petroleum and natural gas sales were $57.8 million, an increase of $6.8 million from the fourth quarter of 2012, primarily due to higher NGLs and natural gas prices and sales volumes, partially offset by lower oil sales volumes. The impact of changes in prices and sales volumes on petroleum and natural gas sales are as follows: Three months ended December 31, 2012 Effect of changes in prices Effect of changes in sales volumes Change in royalty and sulphur revenue Three months ended December 31, 2013 Natural gas 31.6 2.5 1.0 ─ 35.1 NGLs 11.8 3.2 3.2 ─ 18.2 Oil 6.9 ─ (3.0) ─ 3.9 Royalty and Sulphur 0.7 ─ ─ (0.1) 0.6 Total 51.0 5.7 1.2 (0.1) 57.8 Paramount Resources Ltd. 2013Management's Discussion & Analysis47  Sales Volumes Natural Gas (MMcf/d) Three months ended December 31 Oil (Bbl/d) NGLs (Bbl/d) Kaybob Grande Prairie Southern Northern 2013 67.2 21.6 9.4 4.3 2012 % Change 2013 1,520 6 63.3 833 (8) 23.5 243 4 9.0 72 19 3.6 2012 % Change 2013 19 69 378 (17) 139 62 – 85 901 1,008 150 39 Continuing Ops 102.5 99.4 3 2,668 2,098 27 Discontinued Ops Total – 102.5 4.7 104.1 (100) (2) – 2,668 12 2,110 (100) 26 536 – 536 2012 % Change 2013 (70) 19 (75) – 64 317 566 – 12,736 11,501 5,243 4,816 2,223 1,956 639 782 947 (43) 20,290 19,606 11 (8) (12) 22 3 266 1,213 (100) (56) – 1,068 20,290 20,674 (100) (2) Total (Boe/d) 2012 % Change Paramount’s fourth quarter sales volumes averaged 20,290 Boe/d in 2013 compared to 19,606 Boe/d in the fourth quarter of 2012. Increases in natural gas and NGLs sales volumes were primarily related to new well production from the Company’s 2012 / 2013 drilling program at Musreau within the Kaybob COU, including liquids-rich Montney wells. Oil sales volumes decreased mainly due to the sale of properties in the Southern COU. Production within the Kaybob COU continued to be constrained by available owned and contracted natural gas processing capacity in the fourth quarter of 2013. In addition, the Third Party Disruptions that have been impacting the Company’s production since mid-2012 continued in the fourth quarter of 2013, impacting average sales volumes by approximately 4,400 Boe/d (Fourth quarter 2012 – 3,000 Boe/d). Paramount’s fourth quarter production was also impacted by downtime at Company facilities in Musreau and the temporary shut-in of multi-well pads in Grande Prairie to bring new wells on production. Commodity Prices Key monthly average commodity price benchmarks and foreign exchange rates are as follows: Three months ended December 31 Natural Gas AECO daily spot (CDN$/GJ) AECO monthly index (CDN$/GJ) NYMEX (Henry Hub – US$/MMbtu) Crude Oil Edmonton par (CDN$/Bbl) West Texas Intermediate (US$/Bbl) Foreign Exchange $CDN / 1 $US 2013 2012 % Change 3.52 2.99 3.86 86.26 97.46 3.06 2.90 3.40 84.43 88.30 1.05 0.99 15 3 14 2 10 6 Royalties expense decreased $1.6 million to $2.8 million in the fourth quarter of 2013 compared to $4.4 million in the same period in 2012, primarily as a result of lower rates as a greater proportion of production qualified for Alberta new well royalty incentive programs. Paramount Resources Ltd. 2013Management's Discussion & Analysis48  Operating expense increased $3.4 million in the fourth quarter of 2013 compared to the same period in 2012, primarily due to higher processing costs within the Kaybob COU related to utilizing interruptible third-party facilities to increase throughput and higher costs within the Grande Prairie COU including third- party processing facility equalizations and increased repairs and maintenance costs. Paramount’s operating expenses were $10.19 per Boe in the fourth quarter of 2013 compared to $8.63 per Boe in the same period of 2012. The per Boe increase was due to the items noted above, the impacts of which were partially offset by a growing proportion of sales volumes from lower cost Kaybob properties. Net Income (Loss) Three months ended December 31 Principal Properties Strategic Investments Corporate Income tax recovery Income (loss) from continuing operations Discontinued operations, net of tax Net income (loss) Three months ended December 31 Netback Gain (loss) on financial commodity contracts General and administrative Stock-based compensation Depletion and depreciation Exploration and evaluation Gain (loss) on sale of property, plant and equipment Interest Other expenses Income (loss) from equity-accounted investments Other income Income tax recovery Income (loss) from continuing operations Discontinued operations, net of tax Net income (loss) 2013 6.1 12.9 (21.8) 3.1 0.3 – 0.3 2013 29.3 (0.4) (4.6) (8.8) (26.3) (6.6) 6.2 (13.2) (2.0) 19.3 4.3 3.1 0.3 – 0.3 2012 (136.6) (9.1) (14.7) 31.8 (128.6) (23.2) (151.8) 2012 25.8 0.6 (4.0) (7.0) (151.4) (13.6) (1.8) (11.6) (0.8) (0.4) 3.8 31.8 (128.6) (23.2) (151.8) Paramount Resources Ltd. 2013Management's Discussion & Analysis49  Paramount recorded income from continuing operations of $0.3 million for the three months ended December 31, 2013 compared to a loss from continuing operations of $128.6 million in the same period of 2012. Significant factors contributing to the change are shown below: Three months ended December 31 Loss from continuing operations – 2012   Lower depletion, depreciation and impairment mainly due to lower write-downs of petroleum and natural gas properties and goodwill in 2013 Income from equity-accounted investments in 2013 compared to a loss in 2012, mainly due to a $25.1 million dilution gain recorded in respect of Trilogy  Gain on sale of property, plant and equipment compared to a loss in 2012    Other Lower exploration and evaluation expense Lower income tax recovery Income from continuing operations – 2013 (128.6) 125.1 19.7 8.0 7.0 (28.7) (2.2) 0.3 IFDO for the three months ended December 31, 2012 was a loss of $23.2 million, primarily due to $29.5 million of impairment write-downs related to the Northern Discontinued Operations. Funds Flow from Operations (1)(2) The following is a reconciliation of funds flow from operations to the nearest GAAP measure: Three months ended December 31 Cash used in operating activities Change in non-cash working capital Geological and geophysical expenses Asset retirement obligations settled Funds flow from operations Funds flow from operations ($/Boe) (1) Refer to the advisories concerning non-GAAP measures in the Advisories section of this document. (2) Includes the results of discontinued operations. 2013 (6.3) 22.2 1.3 1.1 18.3 9.79 2012 (13.2) 27.2 1.0 2.7 17.7 9.29 Funds flow from operations increased by $0.6 million in the fourth quarter of 2013 compared to the same period in 2012, primarily as a result of higher netbacks due to higher realized prices and higher sales volumes for natural gas and NGLs, partially offset by higher interest and financial commodity contract settlements which contributed to cash flows in 2012. Paramount Resources Ltd. 2013Management's Discussion & Analysis50  Petroleum and natural gas sales – CO Petroleum and natural gas sales – DO Petroleum and natural gas sales Funds flow from operations – CO Funds flow from operations – DO Funds flow from operations Per share – basic and diluted ($/share) Income (loss) – CO Per share – basic ($/share) Per share – diluted ($/share) Net income (loss) Per share – basic ($/share) Per share – diluted ($/share) Sales volumes Natural gas (MMcf/d) NGLs (Bbl/d) Oil (Bbl/d) Total Continuing (Boe/d) Discontinued (Boe/d) Total (Boe/d) Average realized price Natural gas ($/Mcf) NGLs ($/Bbl) Oil ($/Bbl) Continuing ($/Boe) Discontinued ($/Boe) Total ($/Boe) 2013 2012 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 57.8 ─ 57.8 18.3 ─ 18.3 0.19 0.3 ─ ─ 0.3 ─ ─ 102.5 2,668 536 20,290 ─ 20,290 3.73 74.30 78.92 30.99 ─ 30.99 53.9 ─ 53.9 13.4 ─ 13.4 0.14 (37.6) (0.39) (0.39) (37.6) (0.39) (0.39) 100.9 2,535 656 20,022 ─ 20,022 3.10 78.55 100.73 29.27 ─ 29.27 59.5 ─ 59.5 22.3 ─ 22.3 0.24 (22.1) (0.24) (0.24) (22.1) (0.24) (0.24) 59.5 1.8 61.3 17.9 (1.3) 16.6 0.18 (27.7) (0.31) (0.31) 0.3 ─ ─ 107.6 2,126 722 20,790 ─ 20,790 110.8 2,655 861 21,985 606 22,591 3.97 71.84 85.98 31.41 ─ 31.41 3.48 73.76 84.32 30.08 32.95 30.16 51.0 3.6 54.6 16.9 0.8 17.7 0.20 (128.6) (1.49) (1.49) (151.8) (1.69) (1.69) 99.4 2,098 947 19,606 1,068 20,674 3.45 61.14 79.20 28.27 36.61 28.70 38.8 2.5 41.3 15.9 (0.4) 15.5 0.18 (33.5) (0.39) (0.39) (34.6) (0.40) (0.40) 90.6 1,745 900 17,745 967 18,712 2.58 60.55 81.45 23.78 27.96 24.00 40.5 6.0 46.5 10.2 1.9 12.1 0.15 (29.8) (0.35) (0.35) ─ ─ ─ 101.4 1,957 1,064 19,904 1,570 21,474 2.08 69.52 82.74 22.36 42.31 23.82 43.1 11.6 54.7 8.9 3.9 12.8 0.15 127.2 1.49 1.45 124.5 1.46 1.42 83.3 1,589 1,153 16,637 2,176 18,813 2.77 78.96 89.99 28.43 58.51 31.95 Significant Items Impacting Quarterly Results Quarterly earnings variances include the impacts of changing production volumes and market prices:  Fourth quarter 2013 earnings include a $25.1 million dilution gain on the Company’s investment in Trilogy as a result of common shares issued by Trilogy during the quarter and a $7.3 million net impairment reversal of petroleum and natural gas properties.  Third quarter 2013 earnings include a $13.8 million net impairment write-down of petroleum and natural gas properties.  Second quarter 2013 earnings include $16.2 million of exploration expenses and $10.6 million in aggregate gains on the sale of petroleum and natural gas properties. Paramount Resources Ltd. 2013Management's Discussion & Analysis51   First quarter 2013 earnings include $50.8 million in aggregate gains on the sale of petroleum and natural gas properties, partially offset by higher depletion and depreciation due to higher sales volumes.  Fourth quarter 2012 earnings include a $135.6 million write-down of petroleum and natural gas properties and goodwill, and $6.5 million in dry hole charges.  Third quarter 2012 earnings includes $6.2 million in respect of a business interruption insurance settlement related to an electrical equipment failure at the Musreau Refrig Facility in the fourth quarter of 2011.  Second quarter 2012 earnings include a $50.7 million pre-tax gain recognized on the disposition of United States properties.  First quarter 2012 earnings include a $157.2 million pre-tax gain on the sale of 5.0 million Trilogy shares and a $28.3 million gain on the sale of property, plant and equipment, partially offset by higher tax expense, operating expenses and depletion and depreciation. Other Information Related Party Transactions Service Agreements Paramount engages in transactions with Trilogy, MGM Energy, and Paxton Corporation in the normal course of business, including joint venture operations. Paramount is considered related to Trilogy, MGM Energy, and Paxton Corporation because of common significant influence. All transactions between Paramount and these entities are recorded at their exchange amounts. During 2013, Paramount charged $0.4 million (2012 – $0.4 million) to Trilogy in respect of operational and administrative services. Also, Paramount received $8.0 million (2012 – $8.0 million) in dividends from Trilogy. As of December 31, 2013, Paramount had a receivable balance due from Trilogy of $0.3 million (2012 – $0.9 million). Paramount Resources Ltd. 2013Management's Discussion & Analysis52  Contractual Obligations Paramount had the following contractual obligations at December 31, 2013: Cavalier Facility (1) Bank Credit Facility (2) Drilling Rig Facilities (2) Senior notes (2) Transportation and processing commitments (3) Capital spending commitments (4) Operating leases 2014 22.6 3.8 10.1 64.8 40.4 14.2 2.5 158.4 2015-2016 2017-2018 After 2018 ─ 75.7 19.3 129.7 162.3 ─ 4.6 391.6 ─ ─ 30.7 469.2 231.6 ─ 3.8 735.3 ─ ─ ─ 484.3 688.2 ─ 6.9 1,179.4 Total 22.6 79.5 60.1 1,148.0 1,122.5 14.2 17.8 2,464.7 (1) Excluding interest. (2) Including interest and principal repayments. (3) Certain transportation and processing commitments are secured by outstanding letters of credit totaling $32.3 million at December 31, 2013 (2012 - $27.3 million). (4) Relates to contractual obligations for purchases of major equipment. Transportation and processing commitments mainly relate to long-term firm service arrangements for the transportation of natural gas and NGLs and downstream processing of NGLs. Contingencies Paramount is a party to various legal claims associated with the ordinary conduct of business. Paramount does not anticipate that these claims will have a material impact on its financial position. Tax and royalty legislation and regulations, and government interpretation and administration thereof, continually changes. As a result, there are often tax and royalty matters under review by relevant government authorities. All tax and royalty filings are subject to subsequent government audit and potential reassessments. Accordingly, the final liability may differ materially from amounts estimated and recorded. Risk Factors A description of the most significant risk factors related to Paramount and its business is contained in Paramount’s Annual Information Form for the year ended December 31, 2013 under the heading "Risk Factors". Paramount monitors and complies with current government regulations that affect its activities, although the Company and its operations may be adversely affected by changes in government policy, legislation and regulations. Paramount maintains liability, property and business interruption insurance which is believed to be appropriate for the Company’s size and activities. Paramount cannot fully protect against all risks, nor are all risks insurable. The Company may become liable for damages for events which it cannot insure or against which it may elect not to insure due to high premium costs or for other reasons. Refer to "Forward-Looking Information" in the Advisories section of this document and "Risk Factors" in Paramount’s most recent annual information form for additional information. Paramount Resources Ltd. 2013Management's Discussion & Analysis53  Change in Accounting Policies Changes in Accounting Standards Effective January 1, 2013, the Company adopted IFRS 10 – Consolidated Financial Statements, IFRS 11 – Joint Arrangements, IFRS 12 – Disclosure of Interests in Other Entities, IFRS 13 – Fair Value Measurement, IAS 28 – Investments in Associates and Joint Ventures and the amendment to IAS 1 – Presentation of Financial Statements. There has been no impact on the recognized assets, liabilities, or comprehensive income of the Company resulting from the adoption of these standards. Future Changes in Accounting Standards In May 2013, the IASB issued amendments to IAS 36 "Impairment of Assets" which reduce the circumstances in which the recoverable amount of CGUs is required to be disclosed and clarify the disclosures required when an impairment loss has been recognized or reversed in the period. The amendments are required to be adopted retrospectively for fiscal years beginning January 1, 2014, with earlier adoption permitted. These amendments will be applied by Paramount effective January 1, 2014. IFRS 9, "Financial Instruments" sets out the recognition and measurement requirements for financial instruments and some contracts to buy or sell non-financial items. IFRS 9 proposes a single model of classifying and measuring financial assets and liabilities and provides for only two classification categories: amortized cost and fair value. The IASB has removed the effective date for this IFRS as they finalize and complete the various phases of its comprehensive project on financial instruments and its objective to fully replace IAS 39, the current standard on the recognition and measurement of financial instruments. The Company is currently assessing the impact of adopting IFRS 9 on its Consolidated Financial Statements. Disclosure Controls and Procedures As of the year ended December 31, 2013, an evaluation of the effectiveness of Paramount’s disclosure controls and procedures, as defined by the rules of the Canadian Securities Administrators, was performed by the Company’s management with the oversight of the chief executive officer and chief financial officer. Based upon that evaluation, the Company’s chief executive officer and chief financial officer have concluded that as of the end of that fiscal year, the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company is (i) recorded, processed, summarized and reported within the time periods specified in Canadian securities law and (ii) accumulated and communicated to the Company’s management, including its chief executive officer and chief financial officer as appropriate, to allow timely decisions regarding required disclosure. It should be noted that while the Company’s chief executive officer and chief financial officer believe that the Company’s disclosure controls and procedures provide a reasonable level of assurance that they are effective, they do not expect that the Company’s disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Paramount Resources Ltd. 2013Management's Discussion & Analysis54  Internal Controls Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting. The Company’s internal control system was designed to provide reasonable assurance that all transactions are accurately recorded, that transactions are recorded as necessary to permit the preparation of financial statements in accordance with IFRS, that the Company’s assets are safeguarded, and that expenditures are made in accordance with appropriate authorization. Management has assessed the effectiveness of the Company’s internal control over financial reporting as at December 31, 2013. In making its assessment, management used the Committee of Sponsoring Organizations of the Treadway Commission Framework in Internal Control – Integrated Framework (1992) to evaluate the effectiveness of the Company’s internal control over financial reporting. Based on this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2013. Internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate. Changes in Internal Controls Over Financial Reporting During the fiscal year and quarter ended December 31, 2013, there was no change in the Company’s internal control over financial reporting that materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting. Critical Accounting Estimates The timely preparation of financial statements requires management to make certain estimates that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Estimates and assumptions are regularly evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Changes in estimates and assumptions based on new information could result in a material change to the carrying amount of assets or liabilities and have a material impact on revenue and expenses in future periods. A discussion of the accounting estimates that are considered significant follows: Reserves Estimates Reserve engineering is an inherently complex and subjective process of estimating underground accumulations of petroleum and natural gas. The process relies on judgments based on the interpretation of available geological, geophysical, engineering and production data. The accuracy of a reserves estimate is a function of the quality and quantity of available data, the interpretation of that data, the accuracy of various economic assumptions and the judgment of those preparing the estimate. Because these estimates depend on many assumptions, all of which may differ from actual results, reserves estimates, commodity price estimates and estimates of future net revenue will be different from the sales volumes ultimately recovered and net revenues actually realized. Changes in market conditions, Paramount Resources Ltd. 2013Management's Discussion & Analysis55  regulatory matters and the results of subsequent drilling, testing and production may require revisions to the original estimates. Estimates of reserves impact: (i) the assessment of whether a new well has found economically recoverable reserves; (ii) depletion rates; and (iii) the estimated recoverable amount of petroleum and natural gas properties used in impairment assessments, all of which could have a material impact on earnings. Exploration and Evaluation Assets The accounting for exploration and evaluation costs requires management to make judgments as to whether exploratory projects have discovered economically recoverable quantities of reserves, which requires the quantity and value of such reserves to be estimated. Designations are sometimes revised as new information becomes available. Where it is determined that an exploratory project did not discover economically recoverable resources, the costs are written-off as exploration and evaluation expense. If hydrocarbons are encountered, but further appraisal activity is required in order to conclude whether they are commercially viable, the exploratory costs remain capitalized as long as sufficient progress is being made in assessing whether the recovery of the resources is economically viable. The concept of "sufficient progress" is a judgmental area, and it is possible to have exploratory costs remain capitalized for several years while additional drilling is performed or the Company seeks government, regulatory or partner approval for development plans. Exploration and evaluation assets are subject to ongoing technical, commercial and management review to confirm the continued intent to develop and extract the underlying resources. When management is making this assessment, changes to project economics, quantities of resources, expected production techniques, unsuccessful drilling and estimated production costs and projected capital expenditures are important factors. Where it is determined that an exploratory project is not economically viable, the costs are written-off as exploration and evaluation expense. Impairment of Assets The recoverability of the carrying value of oil and gas properties is assessed at the CGU level. Determination of the properties and other assets to be included within a particular CGU is based on management’s judgment with respect to the integration between assets, shared infrastructure and cashflows. Changes in the assets comprising CGUs impacts recoverable amounts used in impairment assessments and could have a material impact on earnings. At the end of each reporting period, the Company is required to identify events or conditions that indicate that the net carrying value of a CGU might be impaired. Management uses judgment to determine if a specific event or condition is an indication of impairment for a CGU. If an indicator of impairment is identified, the asset’s recoverable amount is estimated. The recoverable amount of a CGU is the greater of its fair value less costs to sell and its value in use. In assessing fair value less costs to sell, the Company estimates the value a potential purchaser would ascribe to a CGU. For oil and gas properties, the fair value less costs to sell is estimated based on expected after-tax future net cash flows using forecast commodity prices and costs over the expected economic life of proved and probable reserves, discounted using market-based rates. Value in use is determined by estimating the present value of the future net cash flows expected to be derived from the continued use of the asset or CGU. If the carrying value of an asset or CGU exceeds its estimated recoverable amount, an impairment charge is recognized. Paramount Resources Ltd. 2013Management's Discussion & Analysis56  At the end of each reporting period, the Company must exercise judgment to determine if there are indicators that conditions causing a previous impairment have reversed. Where a new recoverable amount estimate for a CGU exceeds its carrying value, previously recorded impairment adjustments are reversed, up to the amount of the original impairment. Paramount’s independent reserves evaluator evaluated the Company’s reserves as of December 31, 2013. Results of the updated evaluation, in the Company’s judgment, were an indicator of impairment for the Northern and Southern CGUs and an indicator that the conditions causing a previous impairment in the Grande Prairie CGU had partially reversed. As a result, recoverable amounts were estimated for each CGU and adjustments to the carrying value of each CGU were recorded. The recoverable amounts were estimated on a fair value less costs to sell basis, using a discounted cash flow method which is an approach commonly employed by market participants to value oil and gas properties. Cash flows were projected over the expected remaining productive life of each CGU’s proved and probable reserves, at an after-tax discount rate of nine percent at December 31, 2013. Business Combinations Business combinations are accounted for using the acquisition method of accounting, where the net identifiable assets acquired are recorded at fair value. Any excess of the consideration paid over the fair value of the net identifiable assets acquired is recognized as goodwill. Any deficiency in the consideration transferred versus the fair value of the net identifiable assets acquired is recognized in earnings. The fair value of individual assets is often required to be estimated, which may involve estimating the fair values of reserves and resources, tangible assets, undeveloped land, intangible assets and other assets acquired. These estimates are based on assumptions regarding appropriate indicators of fair value. Changes in any of the estimates or assumptions used in determining the fair value of the net identifiable assets acquired may impact the carrying values assigned and earnings. Asset Retirement Obligations Estimates of asset retirement costs are based on assumptions regarding the methods, timing, economic environment and regulatory standards that are expected to exist at the time assets are retired. The Company incorporates information from its current asset retirement projects, internally prepared retirement assessments for select properties, available industry estimates and estimates from regulators in its aggregated estimate of asset retirement obligations. Management adjusts amounts periodically as assumptions are changed to incorporate new information. Actual payments to settle the obligations may differ materially from amounts estimated. Share-Based Payments The Company estimates the grant date value of stock options awarded using the Black-Scholes-Merton model. The inputs used to determine the estimated value of the options are based on assumptions regarding share price volatility, the expected life of the options, expected forfeiture rates and future interest rates. By their nature, these inputs are subject to measurement uncertainty and changes to any of these assumptions impacts amounts recognized as stock-based compensation expense and contributed surplus. Significant Influence An investor is presumed to have significant influence where it holds 20 percent or more of the voting power over an investee, or where significant influence can be clearly demonstrated. Significant influence Paramount Resources Ltd. 2013Management's Discussion & Analysis57  is the power to participate in the financial and operating policy decisions of the investee, but is not control or joint control of the entity. Factors that may demonstrate significant influence include representation on the board of directors of the investee, interchange of management personnel and participation in determining the significant policies of the investee. The Company accounts for its investments in certain entities under the equity method although it holds less than 20 percent of the voting power because, in Management’s judgment, it has significant influence as a result of common directors and members of senior management. Income Taxes Accounting for income taxes is a complex process requiring management to interpret frequently changing laws and regulations and make judgments related to the application of tax law and estimate the timing of temporary difference reversals and estimate the realization of tax assets. All tax filings are subject to subsequent government audits and potential reassessment. These interpretations and judgments and changes related to them impact current and deferred tax provisions, deferred income tax assets and liabilities and net earnings. Deferred tax assets are recognized when it is considered probable that deductible temporary differences will be recovered in the foreseeable future. To the extent that future taxable income and the application of existing tax laws in each jurisdiction differ significantly from the company’s estimate, the ability of the company to realize the deferred tax assets could be impacted. Advisories FORWARD-LOOKING INFORMATION Certain statements in this document constitute forward-looking information under applicable securities legislation. Forward-looking information typically contains statements with words such as "anticipate", "believe", "estimate", “will”, "expect", "plan", "schedule", "intend", "propose", or similar words suggesting future outcomes or an outlook. Forward looking information in this document includes, but is not limited to:      projected production and sales volumes and growth and the timing thereof (including expected first month production volumes from the Kaybob COU's inventory of behind- pipe wells); forecast capital expenditures; exploration, development, and associated operational plans and strategies (including planned drilling programs, well tie-ins and potential future facility expansions and additions), and the anticipated timing of and/or sources of funding for such activities; anticipated increases in funds flow from operations; projected timelines for, and anticipated costs of, constructing, commissioning and/or starting-up new and expanded deep cut natural gas processing and associated facilities, and the Kaybob COU’s processing capacity following the completion of the deep cut facilities;        anticipated decreases in capital and operating costs; the projected availability of third party processing, transportation, fractionation, de- ethanization and other facilities; the anticipated date for receiving regulatory approvals for the initial phase of Cavalier Energy’s Hoole Grand Rapids oil sands development project; business strategies and objectives; estimated reserves and resources and the discounted present value of future net revenues therefrom; non-core asset dispositions and the timing thereof; and tax pools and attributes. Paramount Resources Ltd. 2013Management's Discussion & Analysis58  Such forward-looking information is based on a number of assumptions which may prove to be incorrect. Assumptions have been made with respect to the following matters, in addition to any other assumptions identified in this document:        future oil, bitumen, natural gas, NGLs and other commodity prices; royalty rates, taxes and capital, operating, general & administrative and other costs; foreign currency exchange rates and interest rates; general economic and business conditions; the ability of Paramount to obtain the required capital to finance its exploration, development and other operations; the ability of Paramount to obtain equipment, services, supplies and personnel in a timely manner and at an acceptable cost to carry out its activities; the ability of Paramount to secure adequate product processing, transportation, fractionation, de-ethanization and storage capacity on acceptable terms;     the ability of Paramount to market its oil, bitumen, natural gas and NGLs successfully to current and new customers; the ability of Paramount and its industry partners to obtain drilling success (including in respect of anticipated production volumes, reserves additions and NGLs yields) and operational improvements, efficiencies and results consistent with expectations; the timely receipt of required governmental and regulatory approvals; and anticipated timelines and budgets being met in respect of drilling programs and other operations (including well completions and tie-ins and the construction, commissioning and start-up of new and expanded facilities). Although Paramount believes that the expectations reflected in such forward looking information is reasonable, undue reliance should not be placed on it as Paramount can give no assurance that such expectations will prove to be correct. Forward-looking information is based on expectations, estimates and projections that involve a number of risks and uncertainties which could cause actual results to differ materially from those anticipated by Paramount and described in the forward looking information. The material risks and uncertainties include, but are not limited to:          fluctuations in oil, bitumen, natural gas, NGLs and other commodity prices; changes in foreign currency exchange rates and interest rates; the uncertainty of estimates and projections relating to future revenue, future production, NGLs yields, royalty rates, taxes and costs and expenses; the ability to secure adequate product processing, transportation, fractionation, de-ethanization and storage capacity on acceptable terms; operational risks in exploring for, developing and producing crude oil, bitumen, natural gas and NGLs; the ability to obtain equipment, services, supplies and personnel in a timely manner and at an acceptable cost; potential disruptions or unexpected technical or other difficulties in designing, developing, expanding or operating new, expanded or existing facilities (including third party facilities); industry wide processing, pipeline, de- ethanization, and fractionation infrastructure outages, disruptions and constraints; risks and uncertainties involving the          general business, economic and market conditions; the ability to generate sufficient cash flow from operations and obtain financing at an acceptable cost to fund planned exploration, development and operational activities and meet current and future obligations (including costs of anticipated new and expanded facilities and other projects and product processing, transportation, fractionation, de-ethanization and similar commitments); changes in, or in the interpretation of, laws, regulations or policies (including environmental laws); the ability to obtain required governmental or regulatory approvals in a timely manner, and to enter into and maintain leases and licenses; the effects of weather; the timing and cost of future abandonment and reclamation obligations and potential liabilities for environmental damage and contamination; uncertainties regarding aboriginal claims and in maintaining relationships with local populations and other stakeholders; the outcome of existing and potential lawsuits, regulatory actions, audits and assessments; and other risks and uncertainties described elsewhere in this document and in Paramount’s other filings Paramount Resources Ltd. 2013Management's Discussion & Analysis59   geology of oil and gas deposits; the uncertainty of reserves and resources estimates; with Canadian securities authorities. The foregoing list of risks is not exhaustive. For more information relating to risks, see the section titled "RISK FACTORS" in Paramount's current annual information form. The forward-looking information contained in this document is made as of the date hereof and, except as required by applicable securities law, Paramount undertakes no obligation to update publicly or revise any forward-looking statements or information, whether as a result of new information, future events or otherwise. NON-GAAP MEASURES In this document "Funds flow from operations", "Netback", "Net Debt", "Adjusted Working Capital", "Exploration and development expenditures" and "Investments in other entities – market value", collectively the "Non-GAAP measures", are used and do not have any standardized meanings as prescribed by IFRS. Funds flow from operations refers to cash from operating activities before net changes in operating non-cash working capital, geological and geophysical expenses and asset retirement obligation settlements. Funds flow from operations is commonly used in the oil and gas industry to assist management and investors in measuring the Company’s ability to fund capital programs and meet financial obligations. Netback equals petroleum and natural gas sales less royalties, operating costs, production taxes and transportation costs. Netback is commonly used by management and investors to compare the results of the Company’s oil and gas operations between periods. Net Debt is a measure of the Company’s overall debt position after adjusting for certain working capital amounts and is used by management to assess the Company’s overall leverage position. Refer to the liquidity and capital resources section of the Company’s Management’s Discussion and Analysis for the period for the calculation of Net Debt and Adjusted Working Capital. Exploration and development expenditures refer to capital expenditures and geological and geophysical costs incurred by the Company’s COUs (excluding land and acquisitions). The exploration and development expenditure measure provides management and investors with information regarding the Company’s Principal Property spending on drilling and infrastructure projects, separate from land acquisition activity. Investments in other entities – market value reflects the Company’s investments in enterprises whose securities trade on a public stock exchange at their period end closing price (e.g. Trilogy, MEG Energy, MGM Energy, Strategic and others), and investments in all other entities at book value. Paramount provides this information because the market values of equity-accounted investments, which are significant assets of the Company, are often materially different than their carrying values. Non-GAAP measures should not be considered in isolation or construed as alternatives to their most directly comparable measure calculated in accordance with GAAP, or other measures of financial performance calculated in accordance with GAAP. The Non-GAAP measures are unlikely to be comparable to similar measures presented by other issuers. OIL AND GAS MEASURES AND DEFINITIONS This document contains disclosures expressed as "Boe", "MBoe" and "Boe/d". All oil and natural gas equivalency volumes have been derived using the ratio of six thousand cubic feet of natural gas to one barrel of oil. Equivalency measures may be misleading, particularly if used in isolation. A conversion ratio of six thousand cubic feet of natural gas to one barrel of oil is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the well head. The term "liquids" is used to represent oil and natural gas liquids. During 2013, the value ratio between crude oil and natural gas was approximately 25:1. This value ratio is significantly different from the energy equivalency ratio of 6:1. Using a 6:1 ratio would be misleading as an indication of value. Paramount Resources Ltd. 2013Management's Discussion & Analysis60  Conventional reserve estimates include nominal amounts of volumes and future net revenues related to Paramount’s completed shale gas well. The estimates of reserves and future net revenue for individual properties may not reflect the same confidence level as estimates of reserves and future net revenue for all properties, due to the effects of aggregation. In addition, estimates of future net revenue do not represent fair market value. Finding and Development ("F&D") costs exclude capital costs and reserve volumes related to oil sands and exploratory shale gas properties within Paramount’s Strategic Investments business segment because the relationship between capital amounts invested and reserve volumes discovered for such properties is not comparable to conventional oil and gas properties. Proved reserves additions and P+P reserves additions disclosed herein were calculated as the aggregate of extensions and discoveries and technical revisions included in the reserves reconciliation table. The reserves replacement disclosure herein was calculated as the net increase in P+P reserves estimates from extensions and discoveries, technical revisions and economic factors divided by the Company’s total production in the period. The recycle ratio is calculated by dividing Netback per Boe by F&D costs per Boe. Estimated production from wells that have not yet produced included in the Kaybob COU’s behind pipe inventory is based on the Company’s 4.4 Bcf type curve for Falher formation wells and 3.0 Bcf type curve for Montney formation wells. Oil Sands Resource Notes: This document contains disclosure of certain results of an updated independent evaluation by McDaniel of Cavalier Energy’s bitumen reserves and resources in the Grand Rapids formation in Cavalier’s Hoole oil sands property as of December 31, 2013 (the "Cavalier Evaluation"). Specifically, this document includes McDaniel’s assessment as of December 31, 2013 of Cavalier’s probable reserves, and the low, best and high estimates of economic contingent resources and discovered exploitable bitumen in place in the Grand Rapids formation at Hoole (and the estimated net present value of these probable reserves and economic contingent resources). These terms, as used in the Cavalier Evaluation, have the following meanings: "Probable reserves" are reserves that are less certain to be recoverable than proved reserves. Specifically, whereas proved reserves are reserves that can be estimated with a high degree of certainty to be recoverable (i.e. it is likely that the actual remaining quantities recovered will exceed the estimated proved reserves), in the case of probable reserves it is equally likely that the actual quantities recovered will be greater or less than the estimated probable reserves (or where there are both proved and probable reserves the sum of the estimated proved plus probable reserves). "Contingent resources" are those quantities of bitumen resources estimated, as of a given date, to be potentially recoverable from known accumulations using established technology or technology under development, but which are classified as resources rather than reserves due to one or more contingencies, such as the absence of regulatory applications, detailed design estimates or near term development plans. "Economic contingent resources" are a sub-category of contingent bitumen resources that are considered to be currently economically recoverable based on the reserves evaluator’s then current forecasts of commodity prices and costs. At Hoole, a portion of Cavalier’s economic contingent resources were re-classified by McDaniel as probable reserves by virtue of Cavalier having finalized its plans for a pilot project and submitted a regulatory application for this pilot project. Cavalier will need to finalize plans for the commercial development of the balance of the Hoole oil sands properties and submit regulatory applications for their development before the balance of Cavalier's contingent resources at Hoole can be re-classified as probable reserves. There is no certainty that it will be commercially viable to produce any portion of Cavalier’s contingent resources at Hoole. "Discovered bitumen in place" or "DBIP" (equivalent to discovered resources) is the aggregate quantity of bitumen that is estimated, as of a given date, to be contained in a known accumulation prior to Paramount Resources Ltd. 2013Management's Discussion & Analysis61  production. To qualify as "discovered exploitable bitumen in place" or "DEBIP" these volumes must be contained in a reservoir that meets or exceeds certain characteristics, such as minimum continuous net pay, porosity and mass bitumen content. DBIP or DEBIP volumes that are considered to be recoverable as of a given date are classified as reserves or contingent resources (with the remaining DBIP or DEBIP volumes being those that are considered to be unrecoverable as of that date). At Hoole, DEBIP volumes have been ascribed by McDaniel to those portions of the Grand Rapids formation where they felt minimum continuous net pay, porosity, mass bitumen content and other reservoir characteristics allowed for the commercial application of known recovery technologies. There is no certainty that it will ever be commercially viable to produce any portion of the DEBIP at Hoole. "High Estimate" is considered to be an optimistic estimate of the quantity of resources that will actually be recovered. It is unlikely that the actual remaining quantities of resources recovered will meet or exceed the high estimate. Those resources at the high end for the estimate range have a lower degree of certainty (a 10 percent confidence level) that the actual quantities recovered will equal or exceed the estimate. "Best Estimate" is considered to be the best estimate of the quantity of resources that will actually be recovered. It is equally likely that the actual remaining quantities recovered will be greater or less than the best estimate (or stated another way, there is a 50 percent confidence level that the actual quantities recovered will equal or exceed the best estimate amount). "Low Estimate" is considered to be a conservative estimate of the quantity of resources that will actually be recovered. It is likely that the actual remaining quantities recovered will exceed the low estimate. Those resources at the low end of the estimate range have the highest degree of certainty (a 90 percent confidence level) that the actual quantities recovered will equal or exceed the estimate. "Net present value" or "NPV" of Cavalier’s probable undeveloped reserves and economic contingent reserves at Hoole represents McDaniel’s estimates of Cavalier’s share of future net revenues, before the deduction of income taxes, from these reserves and resources discounted at 10%. In calculating these NPVs McDaniel considered items such as revenues, royalties, operating costs, abandonment costs and capital expenditures (but excluded financing and general and administrative costs). Their calculations assume natural gas is used as a fuel for steam generation, and are based on their forecast commodity prices as of January 1, 2014 and forecast costs as of December 31, 2013. Royalties were calculated based on Alberta’s Royalty Framework applicable to oil sands projects. McDaniel’s estimated NPVs do not represent fair market value. Paramount Resources Ltd. 2013Management's Discussion & Analysis62  FINANCIAL STATEMENTS MANAGEMENT’S REPORT The accompanying Consolidated Financial Statements of Paramount Resources Ltd. (the "Company") are the responsibility of Management and have been approved by the Board of Directors. The Consolidated Financial Statements have been prepared by Management in Canadian dollars in accordance with International Financial Reporting Standards and include certain estimates that reflect Management’s best judgments. When alternative accounting methods exist, Management has chosen those it considers most appropriate in the circumstances. Financial information contained throughout the Company’s annual report is consistent with these Consolidated Financial Statements. Management is also responsible for establishing and maintaining adequate internal control over the Company’s financial reporting. The Company’s internal control system was designed to provide reasonable assurance that all transactions are accurately recorded, that transactions are recorded as necessary to permit preparation of financial statements in accordance with International Financial Reporting Standards, and that the Company’s assets are safeguarded. The Board of Directors is responsible for ensuring that Management fulfills its responsibilities for financial reporting and internal control. The Board of Directors exercises this responsibility through the Audit Committee. The Audit Committee meets regularly with Management and the independent auditors to ensure that Management’s responsibilities are properly discharged and to review the Consolidated Financial Statements. The Audit Committee reports its findings to the Board of Directors for consideration when approving the annual Consolidated Financial Statements for issuance to the shareholders. The Audit Committee also considers, for review by the Board of Directors and approval by the shareholders, the engagement or re-appointment of the independent auditors. The Audit Committee of the Board of Directors is comprised entirely of non-management directors. Ernst & Young LLP, independent auditors appointed by the shareholders of the Company, conducts an examination of the Consolidated Financial Statements in accordance with Canadian generally accepted auditing standards. Ernst & Young LLP has full and free access to the Audit Committee and Management. /s/ Clayton H. Riddell= Clayton H. Riddell Chief Executive Officer= March 6, 2014 /s/ Bernard K. Lee= Bernard K. Lee Chief Financial Officer= Paramount Resources Ltd. 2013Financial Statements63  INDEPENDENT AUDITORS’ REPORT To the shareholders of Paramount Resources Ltd. We have audited the accompanying consolidated financial statements of Paramount Resources Ltd. which comprise the consolidated balance sheets as at December 31, 2013 and 2012 and the consolidated statements of comprehensive loss, shareholders’ equity and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information. Management's responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Paramount Resources Ltd. as at December 31, 2013 and 2012 and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards. Calgary, Canada March 6, 2014 Chartered accountants Paramount Resources Ltd. 2013Financial Statements64  PARAMOUNT RESOURCES LTD. Consolidated Balance Sheet ($ thousands) As at December 31 ASSETS Current assets Cash and cash equivalents Accounts receivable Prepaid expenses and other Assets held for sale Deposit Exploration and evaluation Property, plant and equipment, net Equity-accounted investments Investments in securities Deferred income tax Goodwill LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities Demand facilities Accounts payable and accrued liabilities Risk management Liabilities associated with assets held for sale Long-term debt Asset retirement obligations Commitments and contingencies Shareholders’ equity Share capital Accumulated deficit Reserves See the accompanying notes to these Consolidated Financial Statements. On behalf of the Board Note 2013 2012 20 19 6 18 7 8 9 10 18 11 12 19 19 6 13 14 23 15 16 $ $ $ $ 10,703 39,300 2,252 ─ 52,255 20,437 429,911 1,573,011 104,314 145,661 119,090 3,124 2,447,803 75,550 213,581 3,972 ─ 293,103 882,603 239,853 1,415,559 1,169,178 (224,612) 87,678 1,032,244 2,447,803 $ $ $ $ 146,684 32,790 2,504 12,433 194,411 20,234 405,090 1,078,451 90,977 127,767 116,901 3,124 2,036,955 40,703 183,512 ─ 470 224,685 660,702 300,468 1,185,855 921,680 (165,527) 94,947 851,100 2,036,955 /s/ J.H.T. Riddell J.H.T. Riddell, Director /s/ J.C. Gorman J.C. Gorman, Director Paramount Resources Ltd. 2013Financial Statements65  PARAMOUNT RESOURCES LTD. Consolidated Statement of Comprehensive Loss ($ thousands, except as noted) Year ended December 31 Note 2013 Petroleum and natural gas sales Royalties Revenue Gain (loss) on financial commodity contracts Expenses Operating expense Transportation General and administrative Stock-based compensation Depletion and depreciation Exploration and evaluation Gain on sale of property, plant and equipment Interest Accretion of asset retirement obligations Foreign exchange Income from equity-accounted investments Other income Loss from continuing operations before tax Income tax expense (recovery) Current Deferred Loss from continuing operations Income from discontinued operations, net of tax Net loss Other comprehensive income (loss), net of tax Change in market value of securities Exchange differences on translation of US subsidiaries Comprehensive loss Net income (loss) per common share ($/share) Basic – continuing operations Basic – discontinued operations Basic Diluted – continuing operations Diluted – discontinued operations Diluted See the accompanying notes to these Consolidated Financial Statements. 19 17 8 7 14 9 5 18 4 16 15 $ $ $ 230,722 (10,814) 219,908 (3,972) 215,936 69,847 22,550 19,481 25,851 152,935 35,537 (32,688) 52,639 3,099 528 349,779 21,378 6,757 (105,708) 4,983 (23,576) (18,593) (87,115) 28,030 (59,085) 3,908 393 4,301 (54,784) (0.93) 0.30 (0.63) (0.93) 0.30 (0.63) $ 2012 (restated see note 4) 173,367 (14,277) 159,090 2,487 161,577 55,610 20,196 18,140 29,082 248,888 32,955 (26,432) 35,324 2,899 1,583 418,245 153,333 14,290 (89,045) 789 (25,157) (24,368) (64,677) 2,765 (61,912) (42,830) 438 (42,392) (104,304) (0.75) 0.04 (0.71) (0.75) 0.04 (0.71) $ $ Paramount Resources Ltd. 2013Financial Statements66  PARAMOUNT RESOURCES LTD. Consolidated Statement of Cash Flows ($ thousands) Year ended December 31 Note 2013 2012 Operating activities Net loss Add (deduct): Items not involving cash Dividends from equity-accounted investments Asset retirement obligations settled Current tax related to the sale of U.S. properties Change in non-cash working capital Cash from operating activities Financing activities Net draw of demand loans Net draw (repayment) of revolving long-term debt Proceeds from Senior Notes, net of issue costs Common shares issued, net of issue costs Common shares purchased under stock incentive plan Cash from financing activities Investing activities Property, plant and equipment and exploration Proceeds on sale of property, plant and equipment Proceeds on sale of discontinued operations, net Proceeds on sale of investment, net Investments in securities Investments in equity-accounted investees Change in non-cash working capital Cash used in investing activities Net increase (decrease) Foreign exchange on cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental cash flow information See the accompanying notes to these Consolidated Financial Statements. $ (59,085) $ (61,912) 109,550 8,040 (6,336) 4,915 (12,171) 44,913 34,847 71,826 148,507 217,369 (3,998) 468,551 (736,172) 37,875 9,062 10,097 (9,915) ─ 38,730 (650,323) (136,859) 878 146,684 10,703 101,013 8,040 (8,002) 3,931 12,150 55,220 17,861 (61,383) 294,135 124,465 (3,052) 372,026 (623,631) 45,231 66,498 181,718 (13,023) (1,650) 36,008 (308,849) 118,397 (713) 29,000 146,684 $ 20 14 12 13 13 $ 20 Paramount Resources Ltd. 2013Financial Statements67  PARAMOUNT RESOURCES LTD. Consolidated Statement of Shareholders’ Equity ($ thousands, except as noted) Year ended December 31 2013 2012 Shares (000’s) Note Shares (000’s) Share Capital Balance, beginning of year Issued Change in unvested common shares for stock incentive plan 17 Balance, end of year Accumulated Deficit Balance, beginning of year Net loss Balance, end of year Reserves Balance, beginning of year Other comprehensive income (loss) Contributed surplus Balance, end of year Total Shareholders’ Equity See the accompanying notes to these Consolidated Financial Statements. 89,857 7,133 3 96,993 $ 921,680 247,582 (84) $ 1,169,178 85,414 4,432 11 89,857 $ 810,781 110,896 3 $ 921,680 16 $ (165,527) (59,085) $ (224,612) $ 94,947 4,301 (11,570) $ 87,678 $ 1,032,244 $ (103,615) (61,912) $ (165,527) $ 116,670 (42,392) 20,669 $ 94,947 $ 851,100 Paramount Resources Ltd. 2013Financial Statements68  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 1. SIGNIFICANT ACCOUNTING POLICIES Paramount Resources Ltd. ("Paramount" or the "Company") is an independent, publicly traded, Canadian corporation that explores for and develops conventional petroleum and natural gas prospects, pursues long-term non-conventional exploration and pre-development projects and holds a portfolio of investments in other entities. Paramount’s principal properties are primarily located in Alberta and British Columbia. Paramount’s operations are divided three business segments, established by management to assist in resource allocation, to assess operating performance and to achieve long-term strategic objectives: i) Principal Properties; ii) Strategic Investments; and iii) Corporate. into Paramount is the ultimate parent company of a consolidated group of companies and is incorporated and domiciled in Canada. The address of its registered office is 4700, 888 3rd Street S.W., Calgary, Alberta, Canada, T2P 5C5. The consolidated group includes the following wholly-owned subsidiaries: Paramount Resources, a partnership, Fox Drilling Inc. ("Fox Drilling"), Cavalier Energy Inc. ("Cavalier Energy") and Summit Resources, Inc. ("Summit"). Paramount also holds a 15 percent equity interest in Trilogy Energy Corp. ("Trilogy"), which is accounted for under the equity method of investment accounting along with certain other investees. These consolidated financial statements of the Company, as at December 31, 2013 and December 31, 2012 and for the years then ended (the "Consolidated Financial Statements"), were authorized for issuance by Paramount’s Board of Directors on March 6, 2014. a) Basis of Preparation These Consolidated Financial Statements comply in all material respects with International Financial Reporting Standards ("IFRS"), are stated in Canadian dollars and have been prepared on a historical cost basis, except for certain financial instruments. The Company’s accounting policies have been applied consistently to all years presented. The financial statements of Paramount’s subsidiaries and partnerships are prepared for the same reporting periods as the parent in accordance with the Company’s accounting policies. All intercompany balances and transactions have been eliminated. Certain comparative figures have been reclassified to conform with the current year’s presentation. In March 2013, Paramount sold its properties in the Bistcho area of Alberta and the Cameron Hills area of the Northwest Territories (the "Northern Discontinued Operations"). In May 2012, Summit closed the sale of all of its operated properties in North Dakota and all of its properties in Montana (the "Southern Discontinued Operations"). Results of the Northern Discontinued Operations and Southern Discontinued Operations have been presented as discontinued operations and prior year comparative results have been adjusted to conform to the current year’s basis of presentation, refer to Note 4. The preparation of these Consolidated Financial Statements requires the use of certain accounting estimates and also requires management to exercise judgment in applying the Company’s accounting policies. Areas involving a higher degree of judgment or complexity, and areas where assumptions and estimates are significant to the Consolidated Financial Statements are described in Note 2. Paramount Resources Ltd. 2013Financial Statements69  Notes to the Consolidated Financial Statements ($ thousands, except as noted) b) Revenue Recognition Petroleum and natural gas sales revenues are recognized when title passes to third parties and the significant risks and rewards of ownership have been transferred. Drilling services are billed to customers on a per-day basis and revenues are recognized as services are rendered and collectability is reasonably assured. When the Company’s drilling rigs (the "Rigs") drill on a property owned by Paramount, the Company capitalizes its working interest share of the drilling expenses and eliminates the associated drilling revenue. c) Cash and Cash Equivalents Cash and cash equivalents are recorded at cost and include short-term investments with maturities of three months or less from the date of acquisition. d) Trade and Other Receivables Accounts receivable are recorded as corresponding amounts of revenue are recognized or costs are incurred on behalf of partners. An allowance for doubtful accounts is recognized based on management’s best estimate of accounts that may not be collectible, which is reviewed and adjusted on a quarterly basis. e) Exploration and Evaluation Costs related to the exploration for and evaluation of hydrocarbon resources, including costs of drilling and completing exploratory wells, acquiring unproved property and estimated asset retirement costs, are initially capitalized, pending determination of technical feasibility and commercial viability. If hydrocarbons are found, but further appraisal activity is required to conclude whether they are commercially viable, the costs continue to be recognized as an asset. All such costs are subject to technical, commercial, and management review at least annually to confirm the continued intent to develop the discovery. Net cashflows from the sale of production from shale gas exploration wells within the Strategic Investments business segment are applied against the capitalized costs of the shale gas projects to which they relate until the overall project is deemed commercially viable. All direct costs related to pre- development activities in connection with oil sands properties are considered pre-operating and are capitalized, including the costs to acquire mineral rights, conduct delineation and pre-production drilling, and design and construct plant and equipment. When a project has been determined to be technically feasible and commercially viable, the exploration and evaluation costs ("E&E") are transferred to petroleum and natural gas assets, subject to an impairment assessment. When the Company determines that a project is no longer viable, its carrying value is charged to earnings. Exploratory geological and geophysical costs, pre-license costs, and annual lease rentals are expensed as incurred. Paramount Resources Ltd. 2013Financial Statements70  Notes to the Consolidated Financial Statements ($ thousands, except as noted) f) Property, Plant and Equipment Petroleum and natural gas assets are carried at cost, net of accumulated depletion, depreciation and impairments, and include costs related to drilling and completing development wells, infrastructure construction, successful E&E projects and asset retirement. Paramount’s Rigs are carried at cost, net of accumulated depreciation. Costs incurred to improve the capabilities of the Rigs, extend their useful lives or replace significant components are capitalized. When a significant component is replaced, the carrying value of the replaced part is written off. Costs incurred to maintain and repair the Rigs are expensed as incurred. Other property, plant and equipment, including leasehold improvements, are carried at cost net of accumulated depreciation. Depletion and Depreciation Capitalized costs of proved oil and gas properties are depleted over estimated volumes of proved developed reserves using the unit-of-production method. For purposes of these calculations, volumes of natural gas production and reserves are converted to barrels on an energy equivalent basis. Depletion rates are revised annually, or more frequently when events dictate. E&E costs are not depleted. Capitalized costs of gathering systems and production equipment are depleted on a unit-of-production basis over the proved developed reserves of the field to which they relate. Capitalized costs of processing plants are depreciated on a straight-line basis over their expected useful lives, which extend up to 20 years. Leasehold improvements are depreciated over the term of the lease. Other assets are depreciated using the declining balance method at rates varying from 35 to 50 percent. The Rigs are depreciated by component over their expected useful lives, which vary from 1,095 to 3,650 drilling days. Impairment of Non-Financial Assets The carrying values of the Company’s non-financial assets, excluding goodwill, are reviewed at each reporting date to determine whether any indicators of impairment are present. If an indicator of impairment is identified, the asset’s recoverable amount is estimated. For the purpose of impairment testing, assets are tested individually or, in certain circumstances, grouped together into a cash- generating unit ("CGU"), which consists of the smallest group of assets that generate cash inflows that are largely independent of the cash inflows of other assets or groups of assets. The recoverable amount of an asset or CGU is the greater of its fair value less costs to sell and its value in use. In assessing fair value less costs to sell, the Company estimates the value a potential purchaser would ascribe to an asset or CGU. For oil and gas properties, the fair value less costs to sell is estimated based on expected after- tax future net cash flows using forecast commodity prices and costs over the expected economic life of proved and probable reserves, discounted using market-based rates. Value in use is determined by estimating the present value of the future net cash flows expected to be derived from the continued use of the asset or CGU. If the carrying value of an asset or CGU exceeds its estimated recoverable amount, an impairment charge is recognized. Paramount Resources Ltd. 2013Financial Statements71  Notes to the Consolidated Financial Statements ($ thousands, except as noted) When it is determined that there has been a subsequent increase in the recoverable amount ascribed to an asset or CGU, reversals of impairments are recognized, net of any depletion and depreciation that would have been recorded since the date of the impairment charge. g) Joint Arrangements Paramount recognizes its proportionate share of the revenues, expenses, assets, and liabilities of jointly controlled operations. Interests in joint ventures are accounted for using the equity method of accounting. All of the Company’s interests in joint control arrangements are accounted for as joint operations, the Company does not currently hold any interests in joint ventures. h) Equity-Accounted Investments Investments in entities over which Paramount has significant influence are accounted for using the equity method. An investor is presumed to have significant influence where it holds 20 percent or more of the voting power over an investee, or where significant influence can be clearly demonstrated. Significant influence is the power to participate in the financial and operating policy decisions of the investee, but is not control or joint control of the entity. Factors that may demonstrate significant influence include representation on the board of directors of the investee, interchange of management personnel and participation in determining the significant policies of the investee. Under the equity method, an equity investment is recognized at cost on acquisition, with the carrying amount subsequently increased or decreased to reflect the investor’s proportionate share of the profit or loss of the investee after the date of acquisition. Distributions received from an investee reduce the carrying amount of the investor’s investment. When necessary, adjustments are made to investee financial statements to align accounting policies of investees with those applied by the Company in its Consolidated Financial Statements. The carrying values of the Company’s equity-accounted investments are reviewed at each reporting date to determine whether any indicators of impairment are present. If an indicator of impairment is identified, the recoverable amount of the investment is estimated. If the carrying value of the investment exceeds the estimated recoverable amount, an impairment charge is recognized. i) Business Combinations and Goodwill Business combinations are accounted for using the acquisition method of accounting. Under this method, the net identifiable assets acquired are measured at fair value on acquisition date. Any excess of the consideration paid over the fair value of the net identifiable assets acquired is recognized as goodwill. Any deficiency in the consideration transferred versus the fair value of the net identifiable assets acquired is recognized in earnings. Costs incurred to affect the transaction are expensed. Goodwill is tested for impairment at least annually, or when a potential impairment indicator is identified. To test goodwill for impairment, the carrying value of a CGU (or group of CGUs), including allocated goodwill, is compared to that CGU’s (or group of CGUs’) estimated recoverable amount. An impairment charge is recognized to the extent that the carrying amount of the CGU (or group of CGUs), including goodwill, exceeds its estimated recoverable amount. Impairment charges relating to goodwill are not reversed in future periods. Paramount Resources Ltd. 2013Financial Statements72  Notes to the Consolidated Financial Statements ($ thousands, except as noted) For the purpose of testing goodwill for impairment, the recoverable amount of a CGU (or group of CGUs) is estimated on the same basis as used in testing the assets of that CGU for impairment. j) Borrowing Costs Borrowing costs directly associated with the acquisition, construction or production of a qualifying asset are capitalized while the asset is being constructed or otherwise prepared for its intended productive use. All other borrowing costs are recognized as an expense in the period incurred. k) Asset Retirement Obligations Asset retirement obligations arise from legal obligations to retire assets including oil and gas wells, gathering systems, processing plants and access roads at the end of their productive lives. Paramount recognizes the present value of an asset retirement obligation in the period in which it is incurred and when its fair value can be reasonably estimated. The present value of the obligation is determined using the applicable period-end risk free discount rate, after applying an estimated cost inflation factor, and is adjusted for the passage of time, which is recognized as accretion expense. Revisions to the timing, amount, discount rate and inflation rate relating to the estimated liability are accounted for prospectively by recording an adjustment to the asset retirement obligation liability, with a corresponding adjustment to the carrying value of the related asset. The present value of estimated future asset retirement costs are capitalized as part of the related long-lived asset and depreciated on the same basis as the underlying asset. Actual costs incurred to retire assets are applied against the asset retirement obligation liability. Differences between the actual costs incurred and the liability accrued are recognized in earnings when reclamation of the area is fully complete. l) Foreign Currency Translation Paramount’s functional and presentation currency is the Canadian dollar. The functional currencies of the Company’s subsidiaries are determined by the nature and location of their operations, and amounts included in their individual financial statements are measured in that functional currency. The functional currency of the Company’s United States subsidiaries was changed to the Canadian dollar following the sale of the Company’s remaining United States properties in the first quarter of 2013. For Paramount and its subsidiaries with a Canadian dollar functional currency, monetary assets and liabilities that are denominated in foreign currencies are translated into Canadian dollars at the period-end exchange rate. Gains or losses are recognized in earnings. For the purpose of consolidation, the assets and liabilities of subsidiaries with functional currencies that are not the Canadian dollar are translated into Canadian dollars using the period-end exchange rate. Cumulative translation gains and losses related to the translation of foreign subsidiaries are accumulated in reserves. When the Company reduces its net investment in a foreign subsidiary, the corresponding amount of the cumulative translation gain or loss is recognized in earnings. Revenues and expenses denominated in foreign currencies are translated into Canadian dollars at average monthly exchange rates. Paramount Resources Ltd. 2013Financial Statements73  Notes to the Consolidated Financial Statements ($ thousands, except as noted) m) Financial Instruments, Comprehensive Income and Hedges Paramount periodically uses derivative instruments such as forwards, swaps and options to manage its exposure to fluctuations in petroleum and natural gas prices, foreign exchange rates, and interest rates. Financial Instruments Financial instruments are measured at fair value on initial recognition. The measurement of a financial instrument in subsequent periods is dependent upon whether it has been classified as "fair value through profit or loss", "available-for-sale", "held-to-maturity", "loans and receivables", or "other financial liabilities", as defined by the relevant standard. Paramount does not presently employ hedge accounting for any of its financial instruments. All of the Company’s financial instruments have been classified as fair value through profit or loss except the Company’s investments in securities and long-term debt. Fair value through profit or loss financial assets and financial liabilities are measured at fair value and changes in those fair values over time are recognized in earnings. Derivative financial instruments are classified as fair value through profit or loss. Available-for-sale financial assets are measured at fair value and changes in fair values are accumulated in other comprehensive income ("OCI") until the asset is realized, at which time the cumulative gain or loss is recognized in earnings. Held-to-maturity financial assets, loans and receivables and other financial liabilities, including related transaction costs, are measured at amortized cost using the effective interest method. Other Comprehensive Income For Paramount, OCI is comprised of changes in the market value of investments in available-for-sale securities and foreign exchange translation gains and losses relating to the Company’s subsidiaries with a functional currency other than the Canadian dollar. The amounts recorded in OCI each period are presented in the Consolidated Statement of Comprehensive Loss. The cumulative changes in OCI are included in reserves, which is presented within shareholders’ equity in the Consolidated Balance Sheet. n) Estimates of Fair Value Inputs used to estimate fair values incorporated in the preparation of the Consolidated Financial Statements are categorized into three levels in a fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The three levels are defined below. Level One – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that can be accessed at the measurement date. Level Two – Inputs are based on information other than quoted prices included within Level One that are observable for the asset or liability, either directly or indirectly. Level two inputs include: (a) quoted prices for similar assets or liabilities in active markets; (b) quoted prices for identical or similar assets or liabilities in markets that are not active; (c) inputs other than quoted prices that are observable for the asset or liability, for example: (i) interest rates and yield curves observable at commonly quoted intervals; (ii) implied volatilities; and (iii) credit spreads; and Paramount Resources Ltd. 2013Financial Statements74  Notes to the Consolidated Financial Statements ($ thousands, except as noted) (d) market-corroborated inputs. Level Three – Inputs are unobservable. Unobservable inputs are developed using the best information available in the circumstances, which may incorporate Paramount’s own internally generated data. o) Income Taxes Paramount follows the liability method of accounting for income taxes. Under this method, a deferred income tax asset or liability is recognized in respect of any temporary difference between the carrying amount of an asset or liability reported in the Consolidated Financial Statements and its respective tax basis, using substantively enacted income tax rates. Deferred income tax balances are adjusted to reflect changes in substantively enacted income tax rates expected to apply when the underlying assets are realized or liabilities are settled, with adjustments being recognized in the period in which the change occurs. Deferred income tax assets are recognized to the extent future realization is probable. Deferred tax assets are reduced to the extent that it is no longer probable that sufficient taxable earnings will be available to allow all or part of the asset to be recovered. p) Flow-Through Shares The proceeds of flow-through share issuances are allocated between the sale of Paramount’s class A common shares ("Common Shares") and the sale of tax benefits associated with the flow-through feature of the securities. Proceeds are first allocated to share capital based on the market price of Common Shares on the date the offering is priced, with the balance recorded in accounts payable and accrued liabilities based on the difference between the issue price and the market price of Common Shares. As qualifying expenditures intended for renunciation to subscribers are incurred, the Company recognizes a deferred tax liability, reduces the accounts payable and accrued liabilities amount and records any difference as deferred tax expense. q) Stock-Based Compensation Paramount Stock Option Plan Paramount has a stock option plan that enables the Board of Directors or its Compensation Committee to grant to key employees and directors options to acquire Common Shares of the Company ("Paramount Options"). Paramount Options generally vest over five years and expire within six years after the grant date. The provisions of the plan permit the Company to settle the options in Common Shares of the Company or in cash. The Company accounts for Paramount Options as equity-settled stock-based compensation transactions, where the grant date fair value of stock options awarded is recognized as stock-based compensation expense over the vesting period, with a corresponding increase in Contributed Surplus. The grant date fair value of Paramount Options is estimated using the Black-Scholes-Merton model and such value is not adjusted in future periods. The amount of stock-based compensation expense recognized each period reflects the portion of the vesting term that has elapsed and the estimated number of options that are expected to vest. That estimate is adjusted each period such that the cumulative amount recognized on Paramount Resources Ltd. 2013Financial Statements75  Notes to the Consolidated Financial Statements ($ thousands, except as noted) the vesting date reflects the actual number of Paramount Options that ultimately vest. Upon the exercise of a Paramount Option, the Company transfers the cumulative amount recognized in respect of the award from Contributed Surplus to Share Capital. Cavalier Energy Stock Option Plan Cavalier Energy has a stock option plan that enables its Board of Directors to grant to key employees and directors options to acquire common shares of Cavalier Energy ("Cavalier Options"). Cavalier Options generally vest over five years and expire within seven years after the grant date. The provisions of the stock option plan permit Cavalier Energy to settle Cavalier Options in common shares of Cavalier Energy or in cash, at the discretion of Cavalier Energy. Cavalier Options are accounted for as equity-settled stock-based compensation transactions. Stock Incentive Plan Paramount’s stock incentive plan ("SIP") provides that rights to Common Shares may be awarded to employees annually. Common Shares are purchased in the open market and held by an independent trustee until the completion of the vesting period. Generally, one third of an award vests immediately, with the remaining tranches vesting annually over two years. The unvested portion of an award is initially recorded as a reduction of share capital. The cost of the unvested Common Shares is then recognized over the vesting period as stock-based compensation expense, with a corresponding increase to Paramount’s share capital. r) Non-current assets held for sale Non-current assets are reclassified as assets held for sale: (i) when it is expected that their carrying amount will be recovered principally through sale rather than from continuing use; (ii) such assets are available for immediate sale in their present condition subject only to terms that are usual and customary for the sale of such property; and (iii) the completion of the transaction is highly probable. The property is measured at the lower of carrying amount or fair value less costs to sell. Non-current assets held for sale are not depreciated or amortized. 2. SIGNIFICANT ACCOUNTING ESTIMATES, ASSUMPTIONS AND JUDGMENTS The timely preparation of financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosures regarding contingent assets and liabilities. Estimates and assumptions are regularly evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Changes in judgments, estimates and assumptions based on new information could result in a material change to the carrying amount of assets or liabilities and have a material impact on revenue and expenses in future periods. The following is a description of the accounting judgments, estimates and assumptions that are considered significant: Exploration and Evaluation Assets The accounting for exploration and evaluation costs requires management to make judgments as to whether exploratory projects have discovered economically recoverable quantities of reserves, which Paramount Resources Ltd. 2013Financial Statements76  Notes to the Consolidated Financial Statements ($ thousands, except as noted) requires the quantity and value of such reserves to be estimated. Designations are sometimes revised as new information becomes available. Where it is determined that an exploratory project did not discover economically recoverable resources, the costs are written-off as exploration and evaluation expense. If hydrocarbons are encountered, but further appraisal activity is required in order to conclude whether they are commercially viable, the exploratory costs remain capitalized as long as sufficient progress is being made in assessing whether the recovery of the resources is economically viable. The concept of "sufficient progress" is a judgmental area, and it is possible to have exploratory costs remain capitalized for several years while additional drilling is performed or the Company seeks government, regulatory or partner approval for development plans. Exploration and evaluation assets are subject to ongoing technical, commercial and management review to confirm the continued intent to develop and extract the underlying resources. When management is making this assessment, changes to project economics, quantities of resources, expected production techniques, unsuccessful drilling and estimated production costs and projected capital expenditures are important factors. Where it is determined that an exploratory project is not economically viable, the costs are written-off as exploration and evaluation expense. Reserves Estimates Reserve engineering is an inherently complex and subjective process of estimating underground accumulations of petroleum and natural gas. The process relies on judgments based on the interpretation of available geological, geophysical, engineering and production data. The accuracy of a reserves estimate is a function of the quality and quantity of available data, the interpretation of that data, the accuracy of various economic assumptions and the judgment of those preparing the estimate. Because these estimates depend on many assumptions, all of which may differ from actual results, reserves estimates, commodity price estimates and estimates of future net revenue will be different from the sales volumes ultimately recovered and net revenues actually realized. Changes in market conditions, regulatory matters and the results of subsequent drilling, testing and production may require revisions to the original estimates. Estimates of reserves impact: (i) the assessment of whether a new well has found economically recoverable reserves; (ii) depletion rates; and (iii) the estimated recoverable amount of petroleum and natural gas properties used in impairment assessments, all of which could have a material impact on earnings. Determination of CGUs The recoverability of the carrying value of oil and gas properties is assessed at the CGU level. Determination of the properties and other assets to be included within a particular CGU is based on management’s judgment with respect to the integration between assets, shared infrastructure and cashflows. Changes in the assets comprising each CGU impacts recoverable amounts used in impairment assessments and could have a material impact on earnings. Business Combinations Business combinations are accounted for using the acquisition method of accounting, where the net identifiable assets acquired are recorded at fair value. Any excess of the consideration paid over the fair value of the net identifiable assets acquired is recognized as goodwill. Any deficiency in the consideration transferred versus the fair value of the net identifiable assets acquired is recognized in earnings. The fair Paramount Resources Ltd. 2013Financial Statements77  Notes to the Consolidated Financial Statements ($ thousands, except as noted) value of individual assets is often required to be estimated, which may involve estimating the fair values of reserves and resources, tangible assets, undeveloped land, intangible assets and other assets acquired. These estimates incorporate assumptions using appropriate indicators of fair value, as determined by management. Changes in any of the estimates or assumptions used in determining the fair value of the net identifiable assets acquired may impact the carrying values assigned and earnings. Equity Accounted Investments The Company accounts for its investments in certain entities under the equity method although it holds less than 20 percent of the voting power because, in Management’s judgment, it has significant influence as a result of common directors and members of senior management. Asset Retirement Obligations Estimates of asset retirement costs are based on assumptions regarding the methods, timing, economic environment and regulatory standards that are expected to exist at the time assets are retired. Management adjusts estimated amounts periodically as assumptions are changed to incorporate new information. Actual payments to settle the obligations may differ materially from amounts estimated. Share-Based Payments The Company estimates the grant date value of stock options awarded using the Black-Scholes-Merton model. The inputs used to determine the estimated value of the options are based on assumptions regarding share price volatility, the expected life of the options, expected forfeiture rates and future interest rates. By their nature, these inputs are subject to measurement uncertainty and require management to exercise judgment in determining which assumptions are the most appropriate. Income Taxes Accounting for income taxes is a complex process requiring management to interpret frequently changing laws and regulations and make judgments related to the application of tax law, estimate the timing of temporary difference reversals, and estimate the realization of tax assets. All tax filings are subject to subsequent government audits and potential reassessment. These interpretations and judgments and changes related to them impact current and deferred tax provisions, deferred income tax assets and liabilities and earnings. 3. CHANGES IN ACCOUNTING STANDARDS Changes in Accounting Standards Effective January 1, 2013, the Company adopted IFRS 10 – Consolidated Financial Statements, IFRS 11 – Joint Arrangements, IFRS 12 – Disclosure of Interests in Other Entities, IFRS 13 – Fair Value Measurement, IAS 28 – Investments in Associates and Joint Ventures and the amendment to IAS 1 – Presentation of Financial Statements. There has been no impact on the recognized assets, liabilities, or comprehensive income of the Company resulting from the adoption of these standards. Paramount Resources Ltd. 2013Financial Statements78  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Future Changes in Accounting Standards In May 2013, the IASB issued amendments to IAS 36 "Impairment of Assets" which reduce the circumstances in which the recoverable amount of CGUs is required to be disclosed and clarify the disclosures required when an impairment loss has been recognized or reversed in the period. The amendments are required to be adopted retrospectively for fiscal years beginning January 1, 2014, with earlier adoption permitted. These amendments will be applied by Paramount effective January 1, 2014. IFRS 9, "Financial Instruments" sets out the recognition and measurement requirements for financial instruments and some contracts to buy or sell non-financial items. IFRS 9 proposes a single model of classifying and measuring financial assets and liabilities and provides for only two classification categories: amortized cost and fair value. The IASB has removed the effective date for this IFRS as they finalize and complete the various phases of its comprehensive project on financial instruments and its objective to fully replace IAS 39, the current standard on the recognition and measurement of financial instruments. The Company is currently assessing the impact of adopting IFRS 9 on its Consolidated Financial Statements. Paramount Resources Ltd. 2013Financial Statements79  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 4. DISCONTINUED OPERATIONS In March 2013, Paramount sold its properties in the Bistcho area of Alberta and the Cameron Hills area of the Northwest Territories for net proceeds of $9.1 million. In May 2012, Summit closed the sale of all of its operated properties in North Dakota and all of its properties in Montana for after-tax cash proceeds of $66.5 million. These properties were included in the Company’s Principal Properties business segment. Details of the income from discontinued operations are presented below: Year ended December 31 Petroleum and natural gas sales Royalties Revenue Expenses Operating expense and production tax Transportation Depletion, depreciation, and write-downs Exploration and evaluation Loss on sale of property, plant and equipment Accretion of asset retirement obligations Other expense Loss from ordinary activities of discontinued operations before tax Gain on sale of discontinued operations Income from discontinued operations before tax Income tax expense – discontinued operations Current Deferred Income from discontinued operations $ 2013 1,796 (24) 1,772 2,841 233 267 29 ─ ─ 3,370 ─ (1,598) 38,985 37,387 $ 2012 23,776 (2,253) 21,523 14,241 1,578 36,665 220 48 484 53,236 (13) (31,726) 50,769 19,043 ─ 9,357 9,357 $ 28,030 3,931 12,347 16,278 2,765 $ The cash flows from discontinued operations, including changes in related non-cash working capital items, are as follows: Year ended December 31 Operating Investing Cash flow from discontinued operations 2013 (926) 9,062 8,136 $ $ 2012 12,231 60,422 72,653 $ $ Paramount Resources Ltd. 2013Financial Statements80  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 5. SEGMENTED INFORMATION Paramount’s operations are divided into three business segments established by management to assist in resource allocation, to assess operating performance and to achieve long-term strategic objectives: Principal Properties: Principal properties consist of: (i) the Kaybob Corporate Operating Unit ("COU"), which includes properties in west central Alberta; (ii) the Grande Prairie COU, which includes properties in the Peace River Arch area of Alberta; (iii) the Southern COU, which includes properties in southern Alberta; and (iv) the Northern COU, which includes properties in northern Alberta and northeast British Columbia. Strategic Investments: Strategic investments include: (i) investments in other entities, including affiliates; (ii) investments in exploration and development stage assets, where there is no near- term expectation of commercial production, but a longer-term value proposition based on spin- outs, dispositions, or future revenue generation, including oil sands and carbonate interests held by Cavalier Energy, and prospective shale gas acreage; and (iii) drilling rigs owned by Fox Drilling. Corporate: Corporate is comprised of income and expense items, including general and administrative expense and interest expense, which have not been specifically allocated to Principal Properties or Strategic Investments. Year ended December 31, 2013 Revenue Loss on financial commodity contracts Expenses Operating expense and transportation General and administrative Stock-based compensation Depletion and depreciation Exploration and evaluation Gain on sale of property, plant and equipment Interest Accretion of asset retirement obligations Foreign exchange Income from equity-accounted investments Other Drilling rig revenue Drilling rig expense Inter-segment eliminations Segment income (loss) Income tax recovery Income from discontinued operations, net of tax Net loss Principal Properties $ 219,908 (3,972) 215,936 92,397 ─ ─ 150,633 34,692 (32,275) ─ 3,082 ─ 248,529 ─ 4,419 ─ ─ (28,174) ─ $ (28,174) Strategic Investments $ ─ ─ ─ ─ 6,765 7,166 9,913 845 (413) 2,400 17 ─ 26,693 21,378 28 42,465 (19,351) 17,827 (12,508) $ 5,319 Corporate ─ $ ─ ─ ─ 12,716 18,685 685 ─ ─ 50,239 ─ 528 82,853 ─ ─ ─ ─ (82,853) ─ $ (82,853) Inter-segment Eliminations $ ─ ─ ─ ─ ─ ─ (8,296) ─ ─ ─ ─ ─ (8,296) ─ ─ (38,279) 17,475 (12,508) 12,508 ─ $ Total $ 219,908 (3,972) 215,936 92,397 19,481 25,851 152,935 35,537 (32,688) 52,639 3,099 528 349,779 21,378 4,447 4,186 (1,876) (105,708) ─ (105,708) 18,593 28,030 $ (59,085) Paramount Resources Ltd. 2013Financial Statements81  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Year ended December 31, 2012 (restated see note 4) Revenue Gain on financial commodity contracts Expenses Operating expense and transportation General and administrative Stock-based compensation Depletion and depreciation Exploration and evaluation Gain on sale of property, plant and equipment Interest Accretion of asset retirement obligations Foreign exchange Income from equity-accounted investments Other Drilling rig revenue Drilling rig expense Inter-segment eliminations Segment income (loss) Income tax recovery Income from discontinued operations, net of tax Net loss Total Assets Principal Properties Strategic Investments Corporate Other Income Year ended December 31 Gain on sale of investments Write-down of available-for-sale investment Drilling rig revenue Drilling rig expense Other Principal Properties $ 159,090 2,487 161,577 75,806 ─ ─ 246,834 31,477 (26,432) ─ 2,877 ─ 330,562 ─ 11,483 ─ ─ (157,502) ─ $(157,502) Strategic Investments ─ $ ─ ─ ─ 6,438 10,879 4,657 1,478 ─ 1,499 22 18 24,991 153,333 ─ 20,884 (10,841) 138,385 (4,295) $ 134,090 Corporate ─ $ ─ ─ ─ 11,702 18,203 338 ─ ─ 33,825 ─ 1,565 65,633 ─ ─ ─ ─ (65,633) ─ $ (65,633) Inter-segment Eliminations $ ─ ─ ─ ─ ─ ─ (2,941) ─ ─ ─ ─ ─ (2,941) ─ ─ (13,422) 6,186 (4,295) 4,295 ─ $ Total $ 159,090 2,487 161,577 75,806 18,140 29,082 248,888 32,955 (26,432) 35,324 2,899 1,583 418,245 153,333 11,483 7,462 (4,655) (89,045) ─ (89,045) 24,368 2,765 $ (61,912) December 31, 2013 December 31, 2012 $ $ 1,772,049 520,983 154,771 2,447,803 $ $ 1,410,129 342,967 283,859 2,036,955 2013 3,656 (3,628) 4,186 (1,876) 4,419 6,757 $ $ 2012 – – 7,462 (4,655) 11,483 14,290 $ $ Other income for the year ended December 31, 2012 includes $6.2 million in respect of a business interruption insurance settlement related to an electrical equipment failure at one of the Company’s facilities in the fourth quarter of 2011. Paramount Resources Ltd. 2013Financial Statements82  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 6. ASSETS HELD FOR SALE During the first quarter of 2013, Summit closed the sale of its non-operated joint venture operations and lands in North Dakota for proceeds of US$21.8 million. The carrying value of the properties and associated liabilities were presented as assets held for sale as at December 31, 2012: Exploration and evaluation Property, plant and equipment, net Asset retirement obligations $ $ 12,270 163 (470) 7. EXPLORATION AND EVALUATION Year ended December 31 Balance, beginning of year Additions Transfer to assets held for sale Transfers to property, plant and equipment Dry hole Expired lease costs Dispositions Foreign exchange Balance, end of year 2013 405,090 203,642 ─ (137,355) (13,862) (14,429) (13,143) (32) 429,911 $ $ 2012 390,742 166,214 (12,270) (111,416) (6,842) (18,550) (2,548) (240) 405,090 $ $ Additions to exploration and evaluation assets totaled $125.9 million (2012 – $119.0 million) for Principal Properties and $77.7 million (2012 – $47.2 million) for Strategic Investments. Exploration and Evaluation Expense Year ended December 31 Geological and geophysical Dry hole Expired lease costs 2013 7,101 14,007 14,429 35,537 $ $ 2012 7,843 6,427 18,685 32,955 $ $ Paramount Resources Ltd. 2013Financial Statements83  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 8. PROPERTY, PLANT AND EQUIPMENT Year ended December 31, 2013 Cost Balance, December 31, 2012 Additions Transfers from exploration and evaluation Dispositions Change in asset retirement provision Currency translation differences Cost, December 31, 2013 Accumulated depletion, depreciation and write-downs Balance, December 31, 2012 Depletion and depreciation Write-downs Dispositions Currency translation differences Petroleum and natural gas assets $ 1,960,833 528,519 137,355 (126,129) (11,220) (2) 2,489,356 $ (949,699) (145,014) (6,279) 103,507 (1) Drilling rigs Other Total $ $ 84,100 17,417 ─ ─ ─ ─ 101,517 $ 20,374 7,461 ─ (682) ─ 20 27,173 (18,420) (9,382) ─ ─ ─ $(18,737) (1,218) ─ 220 (12) $ 2,065,307 553,397 137,355 (126,811) (11,220) 18 2,618,046 $ (986,856) (155,614) (6,279) 103,727 (13) Accumulated depletion, depreciation and write-downs, December 31, 2013 Net book value, December 31, 2012 Net book value, December 31, 2013 (997,486) 1,011,134 $ 1,491,870 $ (27,802) 65,680 73,715 (19,747) 1,637 $ 7,426 (1,045,035) 1,078,451 $ 1,573,011 Year ended December 31, 2012 Cost Balance, December 31, 2011 Additions Transfers to assets held for sale Transfers from exploration and evaluation Dispositions Change in asset retirement provision Currency translation differences Cost, December 31, 2012 Accumulated depletion, depreciation and write-downs Balance, December 31, 2011 Transfer to assets held for sale Depletion and depreciation Write-downs Dispositions Currency translation differences Petroleum and natural gas assets $1,466,107 426,808 (1,284) 111,416 (58,305) 15,697 394 1,960,833 $ (696,630) 1,121 (148,174) (135,278) 29,504 (242) Drilling rigs Other Total $ 51,471 32,889 – – – – (260) 84,100 $ 19,943 446 – – – – (15) 20,374 $ (13,899) – (4,630) – – 109 $ (18,375) – (367) – – 5 $1,537,521 460,143 (1,284) 111,416 (58,305) 15,697 119 2,065,307 $ (728,904) 1,121 (153,171) (135,278) 29,504 (128) Accumulated depletion, depreciation and write-downs, December 31, 2012 Net book value, December 31, 2011 Net book value, December 31, 2012 (949,699) 769,477 $1,011,134 (18,420) 37,572 $ 65,680 (18,737) 1,568 1,637 (986,856) 808,617 $1,078,451 $ Paramount Resources Ltd. 2013Financial Statements84  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Depletion and Depreciation Year ended December 31 Depletion and depreciation Write-down of property, plant and equipment Goodwill impairment Inter-segment eliminations 2013 155,701 6,519 ─ (9,285) 152,935 $ $ 2012 145,981 105,802 302 (3,197) 248,888 $ $ At December 31, 2013, $343.7 million (December 31, 2012 – $267.7 million) of capitalized costs related to incomplete development wells and infrastructure projects are currently not subject to depletion. Additions to property, plant and equipment in 2013 were $523.8 million (2012 – $426.8 million) for Principal Properties, $22.1 million (2012 – $32.9 million) for Strategic Investments and $7.5 million (2012 – $0.5 million) for Corporate. Additions to property, plant and equipment include $12.7 million (2012 – $4.6 million) of capitalized interest for qualifying assets in the construction phase at a weighted average interest rate of eight percent (2012 – eight percent). The Company recorded a net impairment write-down of its petroleum and natural gas assets of $6.5 million in 2013 (2012 – $105.8 million), comprised of a $19.6 million write-down related to the Southern CGU and a $17.7 million write-down related to the Northern CGU, net of an impairment reversal of $30.8 million related to the Grande Prairie CGU. These properties are included within the Principal Properties business segment. The impairment write-downs in the Southern and Northern CGUs were recorded because the carrying value of their properties exceeded their recoverable amounts, which were estimated based on expected discounted cash flows from the production of proved and probable reserves. The impairments resulted from a combination of declines in reserves assigned due to well performance and, in the Southern CGU, the sale of properties with recoverable amounts that exceeded their carrying values. The reversal of previously recorded impairment write-downs in the Grande Prairie CGU resulted from increases in reserves assigned to the CGU due to recent drilling programs. The reversal was recorded to the extent that the recoverable amount ascribed to the Grande Prairie CGU exceeded the carrying value of its properties. Recoverable amounts were estimated on a fair value less costs to sell basis, using a discounted cash flow method which is an approach commonly employed by market participants to value oil and gas properties. Cash flows were projected over the expected remaining productive life of each CGU’s reserves, at an after-tax discount rate of nine percent at December 31, 2013 (2012 – eight percent). The forecast prices used to determine the recoverable amount reflect the following benchmark prices, adjusted for basis differentials to determine local reference prices, transportation costs and quality: Paramount Resources Ltd. 2013Financial Statements85  Notes to the Consolidated Financial Statements ($ thousands, except as noted) (Average for the period) 2014 2015 2016 2017 2018 2019-2028 Thereafter Natural Gas AECO ($/MMBtu) Henry Hub (US$/MMBtu) 4.00 4.25 4.25 4.50 4.55 4.75 4.75 5.00 5.00 5.25 5.25 – 6.25 5.50 – 6.55 Crude Oil Edmonton Light ($/Bbl) WTI (US$/Bbl) 95.00 95.00 96.50 95.00 97.50 95.00 98.00 95.00 98.30 95.30 99.60 – 119.10 96.60 – 115.50 +2%/yr +2%/yr +2%/yr +2%/yr Following the sale of the Cameron Hills and Bistcho properties in the first quarter of 2013 and the decline in reserves assigned to the remaining properties in the Northern CGU as at December 31, 2013, Paramount has determined that its remaining Northern properties no longer constitute a significant CGU. As a result, the remaining Northern properties will be included within the Grande Prairie CGU subsequent to December 31, 2013. The Company recorded a net impairment write-down in 2012 related to its petroleum and natural gas assets of $105.8 million within the Principal Properties business segment, comprised of a $48.2 million write-down related to the Grande Prairie CGU, a $32.8 million write-down related to the Northern CGU and a $24.8 million write-down related to the Southern CGU. The impairments were recorded to the extent that the carrying value of the properties exceeded their expected discounted cash flows from the production of estimated proved and probable reserves. The impairment resulted from a combination of the decline in forecast oil, natural gas, and natural gas liquids prices, higher well costs than reserves values assigned, and declines in reserves assigned due to well performance. The following benchmark prices were used in determining the 2012 estimates of recoverable amounts: (Average for the period) 2013 2014 2015 2016 2017 2018-2027 Thereafter Natural Gas AECO ($/MMBtu) Henry Hub (US$/MMBtu) 3.35 3.75 3.85 4.30 4.35 4.85 4.70 5.25 5.10 5.70 5.45 – 6.50 6.10 – 7.25 +2%/yr +2%/yr Crude Oil Edmonton Light ($/Bbl) WTI (US$/Bbl) 87.50 92.50 90.50 92.50 92.60 93.60 94.50 95.50 96.40 97.40 98.30 – 117.50 99.40 – 118.80 +2%/yr +2%/yr 9. EQUITY ACCOUNTED INVESTMENTS As at December 31 Trilogy MGM Energy Corp. ("MGM") Other (1) Based on the period-end trading price. Shares (000’s) 19,144 54,147 2013 Carrying Value $ 97,391 1,212 5,711 $104,314 Market Value(1) Shares (000’s) $ 528,383 8,664 19,144 54,147 2012 Carrying Value $ 82,419 2,299 6,259 $ 90,977 Market Value(1) $ 557,292 13,537 Paramount Resources Ltd. 2013Financial Statements86  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Income from equity-accounted investments is comprised of the following: Year ended December 31 Equity loss Dilution gain Gain on sale 2013 (4,297) 25,675 ─ 21,378 $ $ 2012 $ (4,298) 416 157,215 $ 153,333 As at December 31, 2013, Paramount owned a 15 percent equity interest in Trilogy (December 31, 2012 – 16 percent). Trilogy is a petroleum and natural gas-focused Canadian energy corporation that develops, produces and sells natural gas, crude oil and natural gas liquids, primarily in the province of Alberta. Trilogy is a publicly listed entity in Canada with its common shares trading on the Toronto Stock Exchange. The following tables summarize the assets, liabilities, equity, revenue and income of Trilogy and Paramount’s investment in Trilogy: As at December 31 Current assets Non-current assets(1) Current liabilities Non-current liabilities Equity Multiply by: Paramount’s equity interest Paramount’s proportionate share of equity Less: share of share-based compensation recorded in equity of Trilogy Carrying value of Paramount’s investment (1) Includes adjustments to Trilogy’s carrying values required in the application of the equity method of investment accounting to account for shares of Trilogy which were purchased in the open market. Excluding such adjustments, Trilogy’s non-current assets as at December 31, 2013 totaled $1,473,508 (2012 – $1,320,972). 2012 $ 74,139 1,356,916 (118,599) (790,113) $ 522,343 16.4% 85,708 (3,289) 82,419 2013 $ 73,221 1,481,860 (138,744) (742,136) $ 674,201 15.3% $ 103,113 (5,722) 97,391 $ $ $ 2012 Year ended December 31 Revenue $ 399,098 Comprehensive income (loss)(1) (22,700) Paramount’s share of Trilogy’s comprehensive loss (3,725) (1) Includes amortization of the adjustments to Trilogy’s non-current assets required in the application of the equity method of investment 2013 $ 489,819 (17,397) (2,660) $ $ accounting to account for shares of Trilogy purchased in the open market. Excluding such adjustments, Trilogy’s comprehensive income for the year ended December 31, 2013 was $11,467 (2012 – comprehensive loss of $12,133). Trilogy had 7.3 million stock options outstanding (2.6 million exercisable) at December 31, 2013 at exercise prices ranging from $4.85 to $38.74 per share. For the year ended December 31, 2013, Paramount received cash dividends of $8.0 million (2012 – $8.0 million) from Trilogy. Income from equity-accounted investments for the year ended December 31, 2013 also includes $25.7 million of dilution gains related to the Company’s investment in Trilogy as a result of common shares issued by Trilogy during the year. Income from equity-accounted investments for the year ended December 31, 2012 included a $157.2 million gain recognized on the sale of 5.0 million Trilogy shares and a $0.4 million dilution gain. Paramount Resources Ltd. 2013Financial Statements87  Notes to the Consolidated Financial Statements ($ thousands, except as noted) The aggregate carrying amount of the Company’s other equity-accounted investments at December 31, 2013 was $6.9 million (December 31, 2012 – $8.6 million) and Paramount’s share of the income or loss of those investees for the year ended December 31, 2013 was an aggregate net loss of $1.6 million (2012 – net loss of $0.6 million). 10. INVESTMENTS IN SECURITIES As at December 31 2013 2012 MEG Energy Corp. Strategic Oil & Gas Ltd. Other 11. GOODWILL As at December 31 Carrying value, beginning of year Impairment Carrying value, end of year Shares (000’s) 3,700 7,200 Market Value $ 113,257 5,400 27,004 $ 145,661 Shares (000’s) 3,700 ─ Market Value $ 112,628 ─ 15,139 $ 127,767 2013 3,124 ─ 3,124 $ $ 2012 3,426 (302) 3,124 $ $ The carrying amount of goodwill as at December 31, 2013 and December 31, 2012 relates to the Kaybob CGU. The Company recorded an impairment charge of $0.3 million in respect of goodwill related to the Northern CGU in 2012. 12. DEMAND FACILITIES As at December 31 Drilling Rig Facilities Drilling Rig Loan I Drilling Rig Loan II Cavalier Facility Drilling Rig Loans 2013 2012 $ $ 53,000 ─ ─ 22,550 75,550 $ $ ─ 17,766 21,000 1,937 40,703 In 2013, Drilling Rig Loan I and Drilling Rig Loan II were repaid and replaced with a new $57.0 million non-revolving demand loan facility (the "Drilling Rig Facility"). The Drilling Rig Facility was drawn in full at closing and principal payments of $4.0 million were made to December 31, 2013. In connection with the Drilling Rig Facility, an $8.0 million non-revolving demand loan facility was entered into with the same bank to fund the purchase of auxiliary equipment for the drilling rigs (the "Auxiliary Equipment Loan"), which was undrawn at December 31, 2013. Paramount Resources Ltd. 2013Financial Statements88  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Recourse and security for the Drilling Rig Facility and the Auxiliary Equipment Loan (collectively, the "Drilling Rig Facilities") is limited to drilling rigs owned by Fox Drilling and drilling contracts guaranteed by Paramount. Interest on the Drilling Rig Facilities is payable at the bank's prime lending rate or bankers' acceptance rate, as selected at the discretion of the Company, plus an applicable margin. Scheduled principal repayments are $8.0 million annually from 2014 to 2017 with the remaining outstanding principal balance due in 2018. The effective interest rate on the Drilling Rig Facility for the year ended December 31, 2013 was 4.4 percent. The effective combined interest rate for the drilling rig loans for the year ended December 31, 2013 was 4.2 percent (2012 – 4.4 percent). Cavalier Facility Cavalier Energy has a $40.0 million demand loan facility with a syndicate of Canadian banks (the "Cavalier Facility"). Drawings on the Cavalier Facility bear interest at the lenders’ prime lending rates, US base rates, or bankers’ acceptance rates, as selected at the discretion of Cavalier Energy, plus an applicable margin. The Cavalier Facility is non-recourse to Paramount and is secured by all of the assets of Cavalier Energy, including oil sands and carbonate bitumen lands. The effective interest rate on the Cavalier Facility for the year ended December 31, 2013 was 3.4 percent (2012 – 4.7 percent). 13. LONG-TERM DEBT As at December 31 Bank credit facility 8¼% Senior Notes due 2017 7⅝% Senior Notes due 2019 Unamortized financing costs, net of premiums Bank Credit Facility 2013 71,826 370,000 450,000 891,826 (9,223) 882,603 $ $ 2012 ─ 370,000 300,000 670,000 (9,298) 660,702 $ $ Paramount’s bank credit facility (the "Facility") was increased in 2013 from $300 million to $600 million, which is available in two tranches. The first tranche ("Tranche A") has a credit limit and lender commitments of $500 million and is available on a revolving basis to November 30, 2014. In the event the revolving period is not extended, Tranche A would be available on a non-revolving basis for an additional year, at which time it would be due and payable. The second tranche ("Tranche B") is available on a revolving basis, has a credit limit of up to $100 million and is due November 30, 2014 in the event the due date is not earlier extended. The Facility is secured by a first fixed and floating charge over substantially all of the assets of Paramount, excluding assets securing the Drilling Rig Facilities and the Cavalier Facility. Balances drawn under Tranche B are secured by the pledge of certain of the Company’s equity investments from time-to-time. Borrowings under the Facility bear interest at the lenders’ prime lending rates, US base rates, bankers’ acceptance rates, or LIBOR rates, as selected at the discretion of Paramount, plus an applicable margin which is dependent upon the Company’s debt-to-cash flow ratio, the tranche under which borrowings are made and the total amount drawn. The maximum amount that Paramount may borrow under the Facility is subject to periodic review and is dependent upon the Company’s reserves, lenders’ projections of future commodity prices, the value attributed by lenders to Paramount’s other property, and the market Paramount Resources Ltd. 2013Financial Statements89  Notes to the Consolidated Financial Statements ($ thousands, except as noted) value of equity investments pledged by Paramount from time-to-time under Tranche B, among other factors. As at December 31, 2013, $71.8 million was drawn on Tranche A and Tranche B was undrawn. Paramount had undrawn letters of credit outstanding at December 31, 2013 totaling $44.7 million that reduce the amount available to the Company. Senior Notes Paramount has $370 million aggregate principal amount of senior unsecured notes due 2017 (the "2017 Senior Notes") outstanding. The 2017 Senior Notes bear interest at 8.25 percent per annum, payable semi-annually in arrears on June 13 and December 13 in each year and mature on December 13, 2017. The 2017 Senior Notes are direct senior unsecured obligations of Paramount and rank equally with all other senior unsecured indebtedness of the Company. The Company has the right to redeem all or a portion of the 2017 Senior Notes at par, plus accrued and unpaid interest to the date of redemption, plus a redemption premium, if applicable, which varies based on the date of redemption. In December 2012, Paramount completed a public offering of $300 million aggregate principal amount of senior unsecured notes due 2019 (the "2019 Senior Notes") at par. In December 2013, Paramount completed a public offering of an additional $150 million aggregate principal amount of 2019 Senior Notes at a price of $1,007.50 per $1,000 principal amount. Certain officers, management and associates of the Company purchased an aggregate $17.9 million principal amount of 2019 Senior Notes under the two offerings. The 2019 Senior Notes bear interest at 7.625 percent per annum, payable semi-annually in arrears on June 4 and December 4 in each year and mature on December 4, 2019. The 2019 Senior Notes are direct senior unsecured obligations of Paramount and rank equally with all other senior unsecured indebtedness of the Company. The Company has the right to redeem all or a portion of the 2019 Senior Notes at par, plus accrued and unpaid interest to the date of redemption, plus a redemption premium, if applicable, which varies based on the date of redemption. 14. ASSET RETIREMENT OBLIGATIONS Year ended December 31 Asset retirement obligations, beginning of year Retirement obligations incurred Revisions to estimated retirement costs and discount rates Obligations settled Disposal of properties Accretion expense - continuing operations Accretion expense - discontinued operations Transfer to liabilities associated with assets held for sale Other Asset retirement obligations, end of year $ 2013 300,468 35,749 (45,321) (6,336) (48,087) 3,099 ─ ─ 281 $ 239,853 2012 299,202 14,626 441 (8,002) (8,500) 2,899 484 (470) (212) 300,468 $ $ Asset retirement obligations at December 31, 2013 were determined using a weighted average risk-free rate of 3.00 percent (December 31, 2012 – 2.00 percent) and an inflation rate of 2.00 percent Paramount Resources Ltd. 2013Financial Statements90  Notes to the Consolidated Financial Statements ($ thousands, except as noted) (December 31, 2012 – 2.00 percent). These obligations will be settled over the useful lives of the assets, which extend up to 47 years. 15. SHARE CAPITAL Paramount’s authorized share capital consists of an unlimited number of Common Shares without par value and an unlimited number of preferred shares issuable in series. At December 31, 2013, 96,993,129 Common Shares were outstanding, net of 71,495 Common Shares held in trust under the stock incentive program, and no preferred shares were outstanding. In October 2013, Paramount issued 1,115,000 Common Shares on a "flow-through" basis in respect of Canadian exploration expenses ("FTS") at a price of $44.00 per share for gross proceeds of $49.1 million, pursuant to a public offering. Concurrent with the public offering, Paramount issued FTS at a price of $44.00 per share to the Company’s Chairman and Chief Executive Officer and President and Chief Operating Officer and/or companies controlled by them for gross proceeds of approximately $10 million, and to certain other directors, officers, and employees of Paramount and other persons for gross proceeds of approximately $1 million. In May 2013, Paramount issued 4,025,000 Common Shares at a price of $37.50 per share for gross proceeds of $150.9 million pursuant to a public offering. In October 2012 Paramount issued 1,936,000 Common Shares on a "flow-through" basis in respect of Canadian exploration expenses ("CEE") at a price of $31.00 per share and 356,000 Common Shares on a "flow-through" basis in respect of Canadian development expenses ("CDE") at a price of $28.15 per share for aggregate gross proceeds of $70 million, pursuant to a public offering. Certain officers and management of the Company participated in this offering. In September 2012 Paramount issued 646,000 Common Shares on a "flow-through" basis in respect of CEE at a price of $31.00 per share and 1,244,000 Common Shares on a "flow-through" basis in respect of CDE at a price of $28.15 per share to a company controlled by the Company’s Chairman and Chief Executive Officer for aggregate proceeds of $55 million. On issuance of the flow-through shares during the year, a liability of $11.8 million (2012 – $19.8 million) was recognized in accounts payable and accrued liabilities on the issuance of flow-through shares in respect of the Company’s obligation to renounce qualifying expenditures. The Company incurred $6.4 million (2012 – $2.4 million) of transaction costs in respect of these equity offerings, net of tax benefits of $2.1 million (2012 – $0.8 million). Loss per Weighted Average Common Share Year ended December 31 2013 2012 Loss from continuing operations – basic Dilutive effect of Paramount options Loss from continuing operations – diluted Wtd. Avg. Shares (000’s) 93,708 ─ 93,708 Loss from continuing operations (87,115) $ ─ (87,115) $ Wtd. Avg. Shares (000’s) 86,607 ─ 86,607 Loss from continuing operations $ (64,677) ─ (64,677) $ Paramount Resources Ltd. 2013Financial Statements91  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Outstanding Paramount Options can be exchanged for the Company’s Common Shares in accordance with the terms of the stock option plan. As a result, they are considered potentially dilutive and are included in the calculation of Paramount’s diluted per share calculations when they are dilutive to income from continuing operations. 16. RESERVES Reserves at December 31, 2013 include unrealized gains and losses related to changes in the market value of the Company’s investments in securities and contributed surplus amounts in respect of Paramount Options and Cavalier Options. The changes in reserves are as follows: Balance, December 31, 2012 Other comprehensive income Stock-based compensation Stock options exercised Balance, December 31, 2013 Balance, December 31, 2011 Other comprehensive income (loss) Stock-based compensation Stock options exercised Balance, December 31, 2012 Unrealized gains (losses) on securities $ $ 8,879 3,908 ─ ─ 12,787 Translation of foreign subsidiaries (393) 393 ─ ─ ─ $ $ Unrealized gains (losses) on securities 51,709 (42,830) ─ ─ 8,879 $ $ Translation of foreign subsidiaries (831) 438 ─ ─ (393) $ $ Contributed surplus $ $ 86,461 ─ 28,252 (39,822) 74,891 Total reserves $ 94,947 4,301 28,252 (39,822) $ 87,678 Contributed surplus $ $ 65,792 ─ 26,072 (5,403) 86,461 Total reserves $ 116,670 (42,392) 26,072 (5,403) $ 94,947 Other Comprehensive Income Year ended December 31 Unrealized gain (loss) on securities Change in market value of securities Reclassification of other comprehensive income to earnings Deferred tax Translation of foreign subsidiaries Exchange differences on translation of US subsidiaries Reclassification of other comprehensive income to earnings Other comprehensive income (loss) 2013 2012 $ $ 636 3,628 (356) 3,908 (587) 980 393 4,301 $ $ (43,096) ─ 266 (42,830) 89 349 438 (42,392) Paramount Resources Ltd. 2013Financial Statements92  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 17. SHARE-BASED PAYMENTS Paramount Options Changes in outstanding Paramount Options are as follows: 2013 2012 Number 6,667,850 1,865,000 (1,747,650) (153,000) – 6,632,200 2,407,250 Weighted average exercise price ($/share) 23.58 $ 37.37 8.66 31.98 – 31.20 24.21 $ $ Number 5,767,450 1,340,000 (258,600) (171,000) (10,000) 6,667,850 2,862,134 Balance, beginning of year Granted Exercised Forfeited Expired Balance, end of year Options exercisable, end of year Weighted average exercise price ($/share) $ 20.76 34.01 11.13 28.15 40.09 23.58 14.42 $ $ For options exercised in 2013, the weighted average market price of Paramount’s Common Shares on the dates exercised was $36.25 (2012 – $34.46) The weighted average remaining contractual life and exercise prices of Paramount Options outstanding as of December 31, 2013 are as follows: Exercise Prices $7.19 - $20.00 $20.01 - $30.00 $30.01 - $35.00 $35.01 - $38.00 $38.01 - $40.09 Number 1,174,950 1,038,000 1,456,000 1,701,000 1,262,250 6,632,200 Awards Outstanding Remaining contractual life 0.9 years 2.3 years 4.2 years 5.2 years 3.4 years 3.4 years Weighted average exercise price $ 10.49 $ 29.37 $ 33.89 $ 37.73 $ 40.05 $ 31.20 The grant date fair value of Paramount Options was estimated using the Black-Scholes-Merton model incorporating the following weighted average inputs: Options awarded in 2013 Options awarded in 2012 Weighted average exercise price per share Expected volatility Expected life of share options Pre-vest forfeiture rate Risk-free interest rate Expected dividend yield Weighted average fair value of awards per share $ $ 37.37 36.1% 4.6 years 5.6% 1.6% – 12.13 $ $ 34.01 45.3% 4.7 years 5.0% 1.3% – 13.47 The estimated expected life of the Paramount Options is based on historical exercise patterns. The expected volatility is estimated based on the historical volatility of the trading price of the Company’s Paramount Resources Ltd. 2013Financial Statements93  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Common Shares over the most recent period that is generally commensurate with the expected term of the option. Cavalier Options During 2013, Cavalier Energy granted 3.5 million Cavalier Options, which vest over four years. A total of 3.9 million previously issued Cavalier Options were cancelled during the year, resulting in a net balance of 4.3 million Cavalier Options outstanding at the end of the year. The grant date fair value of Cavalier Options awarded was estimated using the Black-Scholes-Merton model, incorporating the following inputs: expected volatility 60.8% (2012 – 62.4%), expected life 6.0 years (2012 – 6.5 years), risk-free interest rate 2.0% (2012 – 1.5%), pre-vest forfeiture rate of nil (2012 – nil), and expected dividend yield of nil (2012 – nil). The expected life of the Cavalier Options is the term of the option. As Cavalier is a private company, expected volatility is estimated based on the average historical volatility of the trading price of a group of publicly traded oil sands companies which are comparable to Cavalier Energy over the most recent period that is generally commensurate with the expected term of the option. Stock Incentive Plan – Shares Held in Trust Year ended December 31 2013 2012 Balance, beginning of year Shares purchased Change in vested and unvested shares Balance, end of year Employee Benefit Costs Year ended December 31 Stock option plan Stock incentive plan Stock-based compensation expense Salaries and benefits, net of recoveries Shares (000’s) 75 113 (116) 72 $ $ 416 3,998 (3,914) 500 Shares (000’s) 86 124 (135) 75 $ $ 419 3,052 (3,055) 416 2013 21,347 4,504 25,851 13,392 39,243 $ $ 2012 26,072 3,010 29,082 11,951 41,033 $ $ Paramount Resources Ltd. 2013Financial Statements94  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 18. INCOME TAX The following table reconciles income taxes calculated at the Canadian statutory rate to Paramount’s recorded income tax expense (recovery): Year ended December 31 Loss from continuing operations before tax Effective Canadian statutory income tax rate Expected income tax expense (recovery) Effect on income taxes of: Statutory and other rate differences Income from equity-accounted investments Investment in subsidiaries Goodwill impairment Flow-through share renunciations Stock-based compensation Non-deductible items and other Income tax recovery Components of Deferred Income Tax Asset As at December 31 Property, plant and equipment Investments Asset retirement obligations Non-capital losses Other Deferred tax asset 2013 $ (105,708) 25.0% (26,427) $ 2,707 (5,345) 2,186 – 4,223 5,337 (1,274) (18,593) 2013 (91,934) (4,188) 60,006 150,514 4,692 119,090 $ $ $ 2012 (89,045) 25.1% (22,350) $ $ (2,484) (22,441) 2,643 76 8,759 6,534 4,895 (24,368) $ $ 2012 (9,373) (2,761) 75,515 50,466 3,054 $ 116,901 Paramount has $601.5 million (2012 – $208.6 million) of unused tax losses expiring between 2025 and 2033. In addition, Paramount has $180.0 million (2012 – $190.6 million) of deductible temporary differences in respect of investments for which no deferred income tax asset has been recognized. Deferred tax assets are recognized to the extent that it is probable that taxable profits will be available against which deductible temporary differences and unutilized tax losses can be applied. A deferred tax asset related to the carry forward of unutilized tax losses has been recorded as the Company expects that future taxable profits, through a combination of future operating results and gains realized on the disposition of assets, will be sufficient to utilize the deferred tax asset. In 2010, the Company received reassessments from the Canada Revenue Agency (the "CRA") and provincial tax authorities of its income taxes relating to a prior year transaction (the "Reassessments"). Paramount disagrees with the Reassessments and has filed notices of objection with the CRA and provincial tax authorities. Despite its disagreement, and as a condition of its right to proceed with its objection to the Reassessments, the Company was required to deposit approximately $20 million with the CRA, which will remain on account until the dispute is resolved. Paramount Resources Ltd. 2013Financial Statements95  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 19. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT Financial Instruments Financial instruments at December 31, 2013 consisted of cash and cash equivalents, accounts receivable, the Deposit, available-for-sale investments, the demand facilities, accounts payable and accrued liabilities, risk management liabilities and long-term debt. Fair Values of Financial Assets and Liabilities The fair value of financial assets and liabilities are included in the Consolidated Financial Statements at the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced liquidation or sale. The following methods and assumptions were used to estimate the fair values:  Cash and cash equivalents, accounts receivable and accounts payable and accrued liabilities approximate their carrying amounts largely due to the short-term maturities of these instruments. The fair value of the Deposit approximates its carrying amount.  Risk management liabilities are carried at fair values, which are estimated using level two fair value hierarchy inputs including forward market curves and price quotes for similar instruments provided by financial institutions.  Publicly traded available-for-sale investments are carried at their period-end trading price, which are level one fair value hierarchy inputs.  The carrying value of the demand facilities and long-term debt are measured at amortized cost.  The 2017 Senior Notes had a market value of 103.5 percent of their principal amount at December 31, 2013 (December 31, 2012 – 104.1 percent). The 2019 Senior Notes had a market value of 101.0 percent of their principal amount at December 31, 2013 (December 31, 2012 – 100.3 percent). The Senior Notes are carried at amortized cost. Risk management financial instruments outstanding at December 31, 2013 are as follows: Instrument Oil - NYMEX WTI Swap Oil - NYMEX WTI Swap Total Notional 1,000 Bbl/d 2,000 Bbl/d Average Fixed Price US$92.43/Bbl US$91.78/Bbl Fair Value $ (1,015) (2,957) $ (3,972) Remaining Term January - June 2014 January - December 2014 Changes in the fair value of risk management assets and liabilities are as follows: Year ended December 31 Fair value, beginning of year Changes in fair value Settlements paid Fair value, end of year 2013 ─ (3,972) ─ (3,972) $ $ 2012 (2,603) 2,487 116 ─ $ $ Paramount Resources Ltd. 2013Financial Statements96  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Subsequent to December 31, 2013, the Company entered into the following risk management financial instruments: Instrument Natural Gas - AECO Swap Total Notional 20,000 GJ/d Average Fixed Price CAD$4.45/GJ Remaining Term April - October 2014 Risk Management Paramount is exposed to market risks where the fair values or future cash flows of financial instruments fluctuate because of underlying changes in market prices. The principal market risks impacting Paramount are commodity price risk, foreign currency risk, interest rate risk, equity price risk, credit risk and liquidity risk. Paramount periodically uses derivative instruments such as forwards, swaps and options to manage its exposure to fluctuations in crude oil and natural gas prices, foreign exchange rates, and interest rates. Commodity Price Risk At December 31, 2013, assuming all other variables are held constant, a $10 per barrel increase or decrease in the applicable forward market curves would have had the following impact on Paramount’s net earnings from changes in the fair value of financial commodity contracts: Crude Oil Foreign Currency Risk $10 increase (6,800) $ $10 decrease $ 6,800 Paramount is exposed to foreign currency risk on financial instruments denominated in US dollars including cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities. Sales prices of natural gas, crude oil, and natural gas liquids ("NGLs") are determined with reference to US benchmark prices, therefore a strengthening of the Canadian dollar relative to the US dollar will decrease the revenue received for natural gas, crude oil, and NGLs. Paramount’s expenditures are primarily in Canadian dollars but include capital expenditures in US dollars. Interest Rate Risk Paramount is exposed to interest rate risk from time to time on outstanding balances on its floating rate bank credit facilities, and on interest bearing cash and cash equivalents. A one percent increase or decrease in interest rates would have impacted Paramount’s net earnings for the year ended December 31, 2013 by approximately $0.8 million (2012 – $0.5 million) based on the average floating rate credit facility balances outstanding during the year. Paramount’s 2017 Senior Notes and 2019 Senior Notes bear interest at fixed rates and are subject to fair value changes as market interest rates change. Equity Price Risk Paramount is exposed to equity price risk associated with changes in the market value of its investments. Paramount Resources Ltd. 2013Financial Statements97  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Credit Risk Paramount is exposed to credit risk on its financial instruments where a financial loss would be experienced if a counterparty to a financial asset failed to meet its obligations. The Company manages credit risk by endeavoring to enter into contracts with counterparties that possess high credit ratings, employing net settlement agreements, employing letters of credit, and limiting available credit when necessary. The maximum credit risk exposure at December 31, 2013 is limited to the carrying values of accounts receivable. Accounts receivable include balances due from customers and joint venture partners in the oil and gas industry and are subject to normal industry credit risk. At December 31, 2013, Paramount had balances due from one joint venture partner that represented approximately 10 percent of the Company’s total accounts receivable. Liquidity Risk Liquidity risk is the risk that Paramount will be unable to meet its financial obligations. The Company manages liquidity risk by ensuring that it has sufficient cash and cash equivalents, credit facilities and other financial resources available to meet its obligations. The Company forecasts cash flows for a period of at least 12 months to identify financial requirements. These requirements are met through a combination of cash flows from operations, credit facilities, dispositions of assets, and accessing capital markets. In addition to commitments disclosed in Note 23, contractual obligations related to financial liabilities are as follows: 2014 2015 2016 2017 2018 Accounts payable & accrued liabilities(1) $ 204,035 22,550 Cavalier Facility(2) 3,821 Credit Facility(3) 10,159 Drilling Rig Facilities(3) 64,838 Senior Notes(3) $ 305,403 $ – – 75,647 9,813 64,838 $150,298 $ – $ – – 9,468 64,838 – – – 9,122 434,838 $74,306 $ 443,960 $ – – – 21,553 34,313 $55,866 Thereafter $ – – – – 484,313 $ 484,313 Total $ 204,035 22,550 79,468 60,115 1,147,978 $1,514,146 (1) (2) (3) Excluding $9.5 million related to the Company’s obligation to renounce qualifying expenditures for flow-through share issuances. Excluding interest. Including interest. Accounts payable and accrued liabilities As at December 31 Trade and accrued payables Joint venture and royalties Interest payable Flow-through share renunciation obligations 2013 $ 191,783 8,208 4,044 9,546 $ 213,581 2012 $ 163,891 5,618 3,197 10,806 $ 183,512 Paramount Resources Ltd. 2013Financial Statements98  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Terms and conditions of the above financial liabilities:    Trade and accrued payables and joint venture payables are non-interest bearing and are normally settled within 30 – 60 days. Interest on the 2017 Senior Notes is payable semi-annually in arrears on June 13 and December 13 in each year. Interest on the 2019 Senior Notes is payable semi-annually in arrears on June 4 and December 4 in each year. Accounts receivable As at December 31 Revenue receivable Joint venture receivable GST and other 2013 20,214 12,361 6,725 39,300 $ $ 2012 19,412 10,790 2,588 32,790 $ $ Joint venture receivables are non-interest bearing and are generally on 30 day terms. In determining the recoverability of joint venture receivables, the Company performs a risk analysis considering the type and age of the outstanding receivables and the credit worthiness of the counterparties. The Company has determined that there was no impairment of joint venture receivables as at December 31, 2013. There were no significant non-current joint venture receivables as at December 31, 2013 and 2012. 20. CONSOLIDATED STATEMENT OF CASH FLOWS – SELECTED INFORMATION Items not involving cash Year ended December 31 Financial commodity contracts Stock-based compensation Depletion and depreciation Exploration and evaluation Gain on sale of property, plant, and equipment Accretion of asset retirement obligations Foreign exchange Income from equity-accounted investments Deferred income tax Discontinued operations Other 2013 3,972 25,851 152,935 28,436 (32,688) 3,099 599 (21,378) (23,576) (29,361) 1,661 109,550 $ $ 2012 (2,603) 29,082 248,888 25,596 (26,432) 2,899 1,497 (153,333) (25,157) (682) 1,258 101,013 $ $ Paramount Resources Ltd. 2013Financial Statements99  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Supplemental cash flow information Year ended December 31 Interest paid Current tax paid Components of cash and cash equivalents As at December 31 Cash Cash equivalents 2013 64,207 8,117 2013 10,703 ─ 10,703 $ $ $ $ 2012 36,424 1,598 2012 4,575 142,109 146,684 $ $ $ $ 21. CAPITAL STRUCTURE Paramount’s primary objectives in managing its capital structure are to: (i) (ii) maintain a flexible capital structure which optimizes the cost of capital at an acceptable level of risk; maintain sufficient liquidity to support ongoing operations, capital expenditure programs, strategic initiatives, and the repayment of debt obligations when due; and (iii) maximize shareholder returns. Paramount manages its capital structure to support current and future business plans and periodically adjusts the structure in response to changes in economic conditions and the risk characteristics of the Company’s underlying assets and operations. Paramount monitors metrics such as the Company’s debt- to-equity and debt-to-cash flow ratios, among others, to measure the status of its capital structure. The Company has not established fixed quantitative thresholds for such metrics. The capital structure may be adjusted by issuing or repurchasing shares, issuing or repurchasing debt, refinancing existing debt, modifying capital spending programs, and disposing of assets, the availability of any such means being dependent upon market conditions. Paramount Resources Ltd. 2013Financial Statements100  Notes to the Consolidated Financial Statements ($ thousands, except as noted) Paramount’s capital structure consists of the following: As at December 31 Adjusted working capital deficit (surplus)(1) Demand facilities Credit facility Senior notes(2) Net Debt(3) Share capital Accumulated deficit Reserves Total Capital (1) $ 2013 151,780 75,550 71,826 820,000 1,119,156 1,169,178 (224,612) 87,678 $ 2,151,400 $ 2012 (9,271) 40,703 – 670,000 701,432 921,680 (165,527) 94,947 $ 1,552,532 Adjusted working capital excludes risk management assets and liabilities, demand facilities, assets and liabilities held for sale, and accounts payable and accrued liabilities related to the Company’s obligation to renounce qualifying expenditures for flow-through share issuances (December 31, 2013 - $9.5 million, December 31, 2012 - $10.8 million). Excludes unamortized issue premiums and financing costs. Net Debt excludes the $20 million deposit on account with the CRA, pending resolution of the Company’s Notice of Objection (See Note 18). (2) (3) Paramount is subject to covenants under its bank Facility and senior notes agreements which contain certain restrictions on Paramount’s ability to repurchase equity, issue or refinance debt, acquire or dispose of assets, and pay dividends. 22. RELATED PARTY TRANSACTIONS Service Agreements Paramount engages in transactions with Trilogy, MGM Energy and Paxton Corporation ("Paxton") in the normal course of business, including joint venture operations. Paramount is considered related to Trilogy, MGM Energy and Paxton because of common significant influence. All transactions between Paramount and the entities are recorded at their exchange amounts. During 2013, Paramount charged $0.4 million (2012 – $0.4 million) to Trilogy in respect of operational and administrative services. Also, Paramount received $8.0 million (2012 – $8.0 million) in dividends from Trilogy. As of December 31, 2013, Paramount had a net receivable balance due from Trilogy of $0.3 million (2012 – $0.9 million). Compensation of key management personnel Year ended December 31 Salaries and benefits Stock-based compensation 2013 1,857 9,980 11,837 $ $ 2012 1,914 11,039 12,953 $ $ Paramount Resources Ltd. 2013Financial Statements101  Notes to the Consolidated Financial Statements ($ thousands, except as noted) 23. COMMITMENTS AND CONTINGENCIES Paramount had the following commitments as at December 31, 2013: Petroleum and natural gas transportation and processing commitments (1) Operating leases Capital spending commitments(2) Within One Year 40,416 $ After one year but not more than 5 years 393,994 $ More than five years 688,145 $ 2,460 14,174 57,050 $ 8,461 – 402,455 $ 6,878 695,023 – $ (1) (2) Certain of the transportation and processing commitments are secured by outstanding letters of credit totaling $32.3 million at December 31, 2013 (2012 - $27.3 million). Relates to contractual obligations for purchases of major equipment. Operating lease commitment Paramount’s head office lease expires in 2022. The Company incurred office lease costs of $3.5 million in 2013 (2012 – $3.2 million). Flow-Through Shares As a result of flow through share issuances in 2013, Paramount is required to incur and renounce $48.6 million of CEE during 2014. Paramount has incurred sufficient qualifying expenditures to satisfy commitments associated with CEE and CDE flow-through shares issued in 2012. Contingencies Paramount is a party to various legal claims associated with the ordinary conduct of its business. Paramount does not anticipate that these claims will have a material impact on its financial position. Tax and royalty legislation and regulations, and government interpretation and administration thereof, continually changes. As a result, there are often tax and royalty matters under review by relevant government authorities. All tax and royalty filings are subject to subsequent government audit and potential reassessments. Accordingly, the final liability may differ materially from amounts estimated and recorded. 24. SUBSEQUENT EVENTS In February 2014, Paramount entered into an agreement to sell its properties in the Chain - Delia area of Alberta for approximately $12 million in shares of a TSX Venture Exchange listed company. Paramount Resources Ltd. 2013Financial Statements102  C O R P O R A T E I N F O R M A T I O N OFFICERS DIRECTORS C. H. Riddell Chairman of the Board and Chief Executive Officer J. H. T. Riddell President and Chief Operating Officer B. K. Lee Chief Financial Officer E. M. Shier Corporate Secretary L. M. Doyle Corporate Operating Officer G. W. P. McMillan Corporate Operating Officer D. S. Purdy Corporate Operating Officer J. Wittenberg Corporate Operating Officer P. G. Tahmazian V.P. Midstream P. R. Kinvig V.P. Finance and Controller L. A. Friesen Assistant Corporate Secretary C. H. Riddell Chairman of the Board and Chief Executive Officer Paramount Resources Ltd. Calgary, Alberta J. H. T. Riddell President and Chief Operating Officer Paramount Resources Ltd. Calgary, Alberta J. G. M. Bell (1) (3) (4) General Counsel Olympia Trust Company Calgary, Alberta T. E. Claugus (4) President, GMT Capital Corp. Atlanta, Georgia J. C. Gorman (1) (3) (4) Independent Businessman Calgary, Alberta D. Jungé C.F.A. (2) (4) Chairman of the Board Pitcairn Trust Company Bryn Athyn, Pennsylvania HEAD OFFICE 4700 Bankers Hall West 888 Third Street S.W. Calgary, Alberta Canada T2P 5C5 Telephone: (403) 290-3600 Facsimile: (403) 262-7994 www.paramountres.com CONSULTING ENGINEERS McDaniel & Associates Consultants Ltd. Calgary, Alberta AUDITORS Ernst & Young LLP Calgary, Alberta BANKERS Bank of Montreal Calgary, Alberta HSBC Bank Canada Calgary, Alberta The Bank of Nova Scotia Calgary, Alberta Royal Bank of Canada Calgary, Alberta Alberta Treasury Branches Calgary, Alberta The Toronto-Dominion Bank Calgary, Alberta Canadian Imperial Bank of Commerce Calgary, Alberta Canadian Western Bank Calgary, Alberta D. M. Knott (4) Managing General Partner Knott Partners, L.P. Syosset, New York S. L. Riddell Rose President and Chief Executive Officer Perpetual Energy Inc. Calgary, Alberta J. B. Roy (1) (2) (3) (4) Independent Businessman Calgary, Alberta B. M. Wylie (2) Business Executive Calgary, Alberta (1) Member of Audit Committee (2) Member of Environmental, Health and Safety Committee Member of Compensation Committee Member of Corporate Governance Committee (3) (4) REGISTRAR AND TRANSFER AGENT Computershare Trust Company of Canada Calgary, Alberta Toronto, Ontario STOCK EXCHANGE LISTING The Toronto Stock Exchange (“POU”) 4700 Bankers Hall West 888 Third Street S.W. Calgary, Alberta Canada T2P 5C5 Telephone: (403) 290-3600 Facsimile: (403) 262-7994 www.paramountres.com 

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